the cost of inequality: social distance, predatory conduct… · 2019-12-18 · kurt eggert, held...

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THE COST OF INEQUALITY: SOCIALDISTANCE, PREDATORY CONDUCT,

AND THE FINANCIAL CRISIS

RAYMOND H. BRESCIA*

TABLE OF CONTENTS

I. An Overview of the Mortgage Crisis . . . . . . . . . . . . . . . . . 647 R

A. How Did We Get Here? . . . . . . . . . . . . . . . . . . . . . . . . . 647 R

B. The Present Foreclosure Crisis . . . . . . . . . . . . . . . . . . . 650 R

II. Inequality and Financial Crises . . . . . . . . . . . . . . . . . . . . . . 655 R

A. On Game Theory, Trust and Social Distance. . . . . 655 R

B. Income Inequality, Social Distance and theForeclosure Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 669 R

C. Racial Distance and the Foreclosure Crisis . . . . . . . 684 R

III. An Alternative Explanation and a Response. . . . . . . . . . 693 R

A. The CRA: Not Guilty . . . . . . . . . . . . . . . . . . . . . . . . . . . . 694 R

B. The Role of Government Sponsored Entities . . . . 699 R

IV. Moving Forward: Social Distance and FinancialReform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701 R

A. Social Distance, Dodd-Frank and a NewRegulatory Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . 703 R

1. The Bureau of Consumer FinancialProtection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 705 R

2. Strengthened Fair Lending Enforcement . . . . 709 R

3. Reforming Mortgage Laws . . . . . . . . . . . . . . . . . . . 710 R

* Assistant Professor of Law, Albany Law School; J.D., Yale Law School(1992); B.A., Fordham University (1989); formerly the Associate Director of theUrban Justice Center in New York City, a Skadden Fellow at The Legal Aid Societyof New York, law clerk to the Honorable Constance Baker Motley, and staffattorney at New Haven Legal Assistance Association. I am grateful to theparticipants in the Albany Law School Scholarship Workshop Series for theirhelpful comments as I was conceptualizing this piece, especially Timothy D. Lyttonand Kirsten Keefe, and those attendees at the mid-year meeting of the Associationfor American Law Schools in June 2010, where I presented an earlier draft of thispiece, who offered helpful comments and critiques, especially Vicki L. Been,Emma Coleman Jordan, and Florence Wagman Roisman. I would also like tothank Thomas Sander of the Saguaro Seminar for comments on an earlier draft.For their invaluable contributions to this project, I would like to thank my researchassistants, Natalie Bernardi, Meghan McDonough, and Andrew Martingale; and myindefatigable legal assistant, Fredd Brewer.

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642 NYU ANNUAL SURVEY OF AMERICAN LAW [Vol. 66:641

4. Weakening Federal Preemption of StateConsumer Protection Laws . . . . . . . . . . . . . . . . . . 713 R

B. The Community Reinvestment ModernizationAct . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 716 R

C. Social Capital, Social Distance, Regulatory Reformand Financial Crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 718 R

V. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 R

“An imbalance between rich and poor is the oldest and mostfatal ailments of all republics.”

—Plutarch1

“The injunction of Jesus to love others as ourselves is a recogni-tion of self-interest . . . . We have to tolerate the inequality as a wayto achieving greater prosperity and opportunity for all.”

—Lord Brian Griffiths, Vice Chairman, Goldman SachsInternational2

The present financial crisis—what is now commonly referredto as “the Great Recession”3—presents, for many, the opportunityto promote a particular economic and socio-political world viewabout the causes of the crisis. For those on the left, the crisis was theproduct of a deregulatory philosophy with its roots in Reaganomics,which gained a reckless head of steam during the presidency ofGeorge W. Bush.4 On the right, many blame government policies aswell, but not those that promoted de-regulation. Rather, it was lib-eral Democrats, like Presidents Carter and Clinton and Representa-tive Barney Frank, who purportedly pushed the banking industry tolend to people of low-income who had no business being homeown-ers.5 In some ways, the financial crisis is like a Rorschach test: what

1. BRUCE JUDSON, IT COULD HAPPEN HERE: AMERICA ON THE BRINK 76 (2009)(no citation in original).

2. Simon Clark & Caroline Binham, Profit ‘Is Not Satanic,’ Barclays CEO VarleySays (Correct), BLOOMBERG NEWS (Nov. 3, 2009), http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aGR1F_bjSIZw.

3. See Barry Eichengreen & Kevin H. O’Rourke, A Tale of Two Depressions, AD-

VISOR PERSPECTIVES (Apr. 21, 2009), http://www.advisorperspectives.com/newsletters09/pdfs/A_Tale_of_Two_Depressions.pdf; see also Paul Krugman, The GreatRecession Versus the Great Depression, N.Y. TIMES, Mar. 20, 2009, http://krugman.blogs.nytimes.com/2009/03/20/the-great-recession-versus-the-great-depression/.

4. For the ways that deregulation laid the groundwork for the financial crisis,see SIMON JOHNSON & JAMES KWAK, 13 BANKERS: THE WALL STREET TAKEOVER AND

THE NEXT FINANCIAL MELTDOWN 67–72 (2010).5. For an argument that the government programs were responsible for fuel-

ing the financial crisis, see Howard Husock, Op-Ed., Housing Goals We Can’t Afford,N.Y. TIMES, Dec. 11, 2008, at A49; see also Whose [sic] Responsible for Economic Mess?,


2011] SOCIAL DISTANCE AND THE FINANCIAL CRISIS 643

one sees in an ink blot may reveal more about him or her than itdoes about the picture.

Taking a hard look at some of the economic indicators presentin the buildup to the crisis, one such indicator stands out: prior tothe crisis, the United States experienced a stunning increase in in-come inequality.6 This increase was reminiscent of a similar in-crease in income inequality that preceded the great economic crisisof the last century—the Great Depression.7 Given this phenome-non, has income inequality itself had an impact on financial mar-kets to such an extent that it exacerbated, or even led to thesefinancial crises?

There are several potential explanations for the connection be-tween rising income inequality and the great strains on the econ-omy that often follow such inequality. Did rising income for certainsectors lead to an ability to use that income to influence policymak-ing in such a way that favored those sectors? Did such income ine-quality pressure politicians to promote policies that favored easyaccess to credit as a way to mollify lower-income constituents whomight otherwise grow frustrated with their own stagnating wages inthe face of such inequality? These are the types of explanations thatsome have offered to help explain the link between income ine-quality and the Great Recession.8 This Article offers a third: thatboth income inequality and racial inequality created greater socialdistance and that this social distance, in turn, may have led togreater predatory conduct.9 This predatory conduct helped to pro-

CITIZEN, May 2009, at 18, available at http://www.scribd.com/doc/15419200/Whose-Responsible-for-Economic-Mess (arguing that Barney Frank, as well as theClinton and Carter Administrations, are to blame for the financial crisis).

6. See infra Table 3.7. U.S. CONG. JOINT ECON. COMM., 111TH CONG., INCOME INEQUALITY AND THE

GREAT RECESSION 2–3 (2010) (“Income inequality peaked prior to the UnitedStates’ two most severe economic crises—the Great Depression and the GreatRecession.”).

8. See, e.g., JOHNSON & KWAK, supra note 4, at 89–90 (describing increasedinfluence of financial sector on legislative process); infra text accompanying notes83-85 (describing argument concerning use of credit to offset incomeinequalities).

9. For the most part, this predatory conduct took the form of predatory lend-ing, which has been defined as follows:

[T]he process of engaging in unfair and deceptive lending practices and salestechniques that rely on misrepresentation, threats, unfair pressure, and bor-rower ignorance. The goal of predatory lending is to coerce or trick home-owners into obtaining loans with interest rates or fees higher than theborrowers’ credit profiles and the market would justify or loans larger than ordifferent from what the borrowers need, want or can afford.



mote the risky lending practices that led to an asset bubble in realestate and left many middle class borrowers saddled with onerousloans tethered to overvalued homes. Once the bubble burst, suchborrowers were left with mortgage obligations they could not meetand homes they could no longer afford. Since the financial sectorwas so heavily tied to the health of the U.S. home mortgage market,the collapse of that market led to an economic “tsunami”10 thatswamped all other economic sectors, leading to double-digit fore-closure and unemployment rates in many states. The informationpresented here suggests that income and racial inequality may havehelped foster an environment where predatory conduct couldflourish in the home mortgage market. Such predatory conductcrippled home finances and ultimately spread to all sectors of theeconomy.

This Article is organized as follows. Part I presents an overviewof both the financial crisis and the foreclosure crisis embeddedwithin it. Part II discusses the interplay between social distance andpredatory conduct. Part III considers an alternative theory that at-tempts to explain the connection between income inequality andthe present financial crisis. Part IV concludes this Article with ananalysis of the financial reform legislation passed by Congress inthe summer of 2010 to determine to what extent the reformspassed may address social inequality and social distance. Part IValso provides some thoughts on what social distance theory saysabout potential policy responses to the present crisis.

The review of the information presented here reveals severalcompelling findings regarding some of the potential causes of thefinancial crisis, some of which have not received a great deal of at-tention to date. First, differences in economic inequality withinstates correspond to differences in mortgage delinquency rates: i.e.,the greater the income inequality in a state, on average, the greaterthe delinquency rate in that state. Second, the greater the level ofgeneralized trust in a state, the lower that state’s delinquency rate.Third, the higher the social capital in a state, the lower its delin-quency rate. Fourth, the higher the median income in a state, the

Kurt Eggert, Held Up in Due Course: Predatory Lending, Securitization, and the Holder inDue Course Doctrine, 35 CREIGHTON L. REV. 503, 507 (2002).

10. Alan Greenspan, former Federal Reserve Chairman, testified before aHouse of Representatives committee that the “current global financial crisis is a‘once in a century credit tsunami’ . . . .” Greenspan Calls Economic Crisis a ‘CreditTsunami’, PENNLIVE.COM (Oct. 23, 2008), http://www.pennlive.com/midstate/index.ssf/2008/10/greenspan_calls_economic_crisi.html; see also Habib Siddiqui,NRB Council, USA, Corporate America Still Doesn’t Get It (Jan. 17, 2010) (work-ing paper), available at http://ssrn.com/abstract=1537869.



higher the delinquency rate in that state. Fifth, an index of a seriesof indicators—including income inequality within a state, the sizeof the African American population in a state and the median in-come of the African American population in that state—reveals astrong correlation between these indicators and delinquency rates.This correlation suggests not that low-income African Americansare to blame for the foreclosure crisis, but rather that middle-classAfrican Americans were targeted for and steered towards loans onunfair terms, precipitating the foreclosures that are now concen-trated disproportionately in communities of color.

Some cautionary words regarding the use of data in this Articlemust precede this analysis. Admittedly, the data and analysispresented here does not constitute a deeply sophisticated and gran-ular evaluation using complex statistical techniques. Rather, the in-formation presented here, and the manner in which it is presented,is meant solely as a “conversation starter,” a way of looking at fea-tures of the financial crisis in a light that, hopefully, helps to start adialogue about not just the forces that may have been at work in thelead up to the crisis, but also those factors that must be taken intoaccount when considering paths out of it. Furthermore, some ofthe information that I use in this assessment is itself hard to mea-sure: e.g., mortgage delinquency rates and foreclosure rates,11

levels of trust in a community,12 and levels of social capital in acommunity.13 Additionally, the purpose of using this data is not toprove theorems about cause and effect but to inform a discussion.Others have engaged in more in-depth analysis of some of the is-sues addressed in this Article, including, for example, whether, inthe lead up to the financial crisis, borrowers of color may have beensteered into higher cost loans than White borrowers of similar

11. On the challenges to measuring foreclosure and delinquency rates, seeNational Delinquency Survey Facts, MORTGAGE BANKERS ASSOCIATION, 1 (May 2008),http://www.mbaa.org/files/Research/NDSFactSheet.pdf. This fact summary ofthe Association’s survey demonstrates the complexity and challenges in obtainingcurrent and accurate rates, including having to adjust for such things as seasonaltrends and intricacies in state foreclosure statutes. Id.

12. On the difficulties involved with measuring generalized trust in a commu-nity, see Edward L. Glaeser et al., Measuring Trust, 115 Q. J. ECON. 811, 811–12(2000). For a discussion of this topic, see infra text accompanying note 99.

13. On measuring social capital, see Measuring the Dimensions of Social Capital,WORLD BANK, http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTSOCIALDEVELOPMENT/EXTTSOCIALCAPITAL/0,,contentMDK:20305939~menuPK:418220~pagePK:148956~piPK:216618~theSitePK:401015~isCURL:Y,00.html (last visited July 28, 2010). On the challenges of measuring social capital, seeRobert M. Solow, But Verify—Trust: The Social Virtues and the Creation of Prosperity byFrancis Fukuyama, THE NEW REPUBLIC, Sept. 11, 1995, at 36.



creditworthiness.14 While this Article attempts to build on thatwork, its analysis is not intended to establish a causal relationshipbetween any two phenomena. Rather, its purpose is to attempt todraw connections between phenomena and begin a dialogue aboutpotential responses to them.

One of the techniques used most often in analyzing the infor-mation presented in this work is to rank U.S. states according totheir relation to one another using a range of different characteris-tics and sources of data: e.g., the levels of generalized trust in differ-ent states, median incomes in the states, and crime rates. ThisArticle compares these and other data sets to the mortgage delin-quency rates of different states in an attempt to explore the poten-tial connections between the characteristics of the different statesand the level of mortgage distress within their borders. Rather thanpresenting raw data, this Article ranks the states to make the scatterpoint graphs utilized easier to read visually and to present informa-tion that is easier to process and that serves as a better foil forconversation.15

In these ways, this Article attempts to take an approach similarto that used in other settings. Heather Gerken, in her recent workpromoting the use of data analysis to assess the relative success ofthe machinery of democracy in the United States—i.e., our systemof casting votes—takes such an approach.16 There, she argues forthe creation of a “Democracy Index,” one which would help begin adialogue about election reform and help point the way to accom-plishing it. She describes the value of such an approach as follows:

Rather than focusing on necessarily atmospheric judgmentsabout what problems exist, the Index would provide concrete,comparative data on bottom-line results. It would allow us tofigure out not just what is happening in a given state or locality,but how its performance compares to similarly situated juris-

14. See infra text accompanying notes 140–48.15. Much of the raw data underlying the rankings is available in the Appen-

dix. Heather Gerken explains the value of rankings as follows: “Rankings get morepolitical traction than the alternatives, precisely because they reduce the data totheir simplest form.” HEATHER K. GERKEN, THE DEMOCRACY INDEX: WHY OUR ELEC-

TION SYSTEM IS FAILING, AND HOW TO FIX IT 34 (2009) (footnote omitted). Gerkenargues that, through ranking, information can be presented in a “highly intuitive,accessible format . . . .” Id. at 68.

16. Id. The recently released “Economic Security Index” is another exampleof this type of approach. See JACOB S. HACKER ET AL., ECONOMIC SECURITY AT RISK:FINDINGS FROM THE ECONOMIC SECURITY INDEX (2010), available at http://www.economicsecurityindex.org/assets/Economic%20Security%20Index%20Full%20Report.pdf (describing Economic Security Index).



dictions’. It would help us spot, surface, and solve theproblems that afflict our system. The Democracy Index would,in short, give us the same diagnostic tool used routinely by cor-porations and government agencies to figure out what’s work-ing and what’s not.17

This Article seeks to apply this approach to the relationshipbetween trust and predatory conduct; the role of social capital inserving as a check on such predatory conduct; and the interplaybetween race, place and class in the lead up to the financial crisis.The juxtaposition of certain critical pieces of information, aspresented in this Article, will hopefully help inform, and perhapseven shape, what should be an ongoing debate about the need forand the contours of financial reform after the passage of the Dodd-Frank bill.

I.AN OVERVIEW OF THE MORTGAGE CRISIS

A. How Did We Get Here?

The story of the financial crisis has been told many times, andthis Article does not attempt to offer a full recount. Suffice it to say,the most immediate seeds of the crisis were planted in the wake ofthe collapse of the so-called “dot-com” bubble of the late 1990s.The loss in value in that market sector and the attacks of September11, 2001 led the Federal Reserve to lower interest rates in an at-tempt to weaken the recessionary effects of those events.18 A savingsglut in other parts of the world, coupled with lowered interest rates,sent investors looking for higher returns than those they could earnfrom investing in U.S. Treasury securities.19 At the same time, inno-vations in home mortgage finance brought about by the increase insecuritization of mortgages created investment vehicles that offeredinvestors what they wanted: high returns from a seemingly safe

17. GERKEN, supra note 15, at 59. On the mechanics of and values behind thecreation of an effective index, see DAVID ROODMAN, CTR. FOR GLOBAL DEV., BUILD-

ING AND RUNNING AN EFFECTIVE POLICY INDEX: LESSONS FROM THE COMMITMENT TO

DEVELOPMENT INDEX (2006), available at http://cgdev.org/content/publications/detail/6661.

18. Ben S. Bernanke, Chairman, Bd. of Governors of the Fed. Reserve Sys.,Monetary Policy and the Housing Bubble, Address at the Annual Meeting of theAmerican Economic Association 2–3 (Jan. 3, 2010), available at http://www.feder-alreserve.gov/newsevents/speech/bernanke20100103a.htm.

19. DANIEL GROSS, DUMB MONEY: HOW OUR GREATEST FINANCIAL MINDS BAN-

KRUPTED THE NATION 18–20 (2009).



product.20 Questions about the safety of that product—securitizedmortgages—were answered by credit rating agencies that deemedthem “AAA” safe, or the safest securities available.21

These innovations revolutionized the home mortgage marketin the United States by converting the business operations ofthousands of home mortgage lenders who transformed their busi-ness plan from “lend and hold” to “originate to securitize.”22 Lend-ers sought out prospective borrowers, not because those lenderscould profit from the spread between the interest rate at which theyborrowed and the interest rate at which they lent to those custom-ers; rather, their profit came from investment banks that paid thoselenders a fee for writing mortgages and selling them to thosebanks.23 The model was driven by quantity and not quality.24 As thepool of potential borrowers dried up, new mortgage products weredevised that allowed lenders to offer loans through lowered under-writing standards, on terms that few understood and even fewercould afford.25 Exotic adjustable rate mortgages were not to be

20. For an overview of the securitization process and a description of the waysin which mortgage securitization was one of the leading causes of the subprimemortgage crisis, see Kurt Eggert, The Great Collapse: How Securitization Caused theSubprime Meltdown, 41 CONN. L. REV. 1257 (2009).

21. See JOHNSON & KWAK, supra note 4, at 131; Jason Cox, Judith Faucette &Consuelo Valenzuela Lickstein, Why Did the Credit Crisis Spread to Global Markets, inTHE E-BOOK ON INTERNATIONAL FINANCE AND DEVELOPMENT Part 5 (Mar. 2010),http://www.uiowa.edu/ifdebook/ebook2/contents/part5-II.shtml (“Many mort-gage-backed securities received AAA credit ratings, meaning that they were consid-ered among the safest assets on the market.”).

22. As former Securities and Exchange Commissioner Christopher Cox ex-plained before Congress, the “originate to securitize” model was at the heart of thefinancial crisis because of the risks such an approach encouraged: “When mort-gage lending changed from originate-to-hold to originate-to-securitize, an impor-tant market discipline was lost. The lenders no longer had to worry about thefuture losses on the loans, because they had already cashed out.” The Role of FederalRegulators: Lessons from the Credit Crisis for the Future of Regulation, Hearing Before the H.Comm. on Oversight and Gov’t Reform, 110th Cong., 26 (2008) (testimony of Christo-pher Cox, Sec. and Exch. Comm’n).

23. For a description of the new ways that lenders and investment banks couldmake money through securitization, including the sale of the underlying interestto generate more money as well as the fees associated with that sale, see JOHNSON &KWAK, supra note 4, at 76 (“In each case, the revenues available depended on thevolume of mortgage-backed securities.”).

24. John Kiff & Paul Mills, Money for Nothing and Checks for Free: Recent Develop-ments in U.S. Subprime Mortgage Markets 7 (Int’l Monetary Fund, Working Paper No.188, 2007), available at http://www.imf.org/external/pubs/ft/wp/2007/wp07188.pdf.

25. For an overview of the ways in which lenders lowered underwriting crite-ria to recruit new customers, see Allan N. Krinsman, Subprime Mortgage Meltdown:



feared, however, as lenders promised borrowers the ability to refi-nance their loans after a short period of time (i.e., before the inter-est rate adjusted upwards), assuming, of course, that the value ofthe home securing the mortgage would continue to rise;26 other-wise such an approach would not work. The idea that a single bor-rower could generate an initial loan and then could refinance thatloan, perhaps even multiple times, held out the promise of a steadystream of income for the lender, who would collect a new set of feeswith each transaction.27

As home values reached unsustainable heights, fueled by theavailability of easy credit,28 lenders began to pull back on the reins,and borrowers could no longer refinance their mortgages.29 Ascredit dried up, borrowers began to fall behind on their mortgagesas their interest rates reset to unaffordable levels through opaqueformulas that masked their potential for economic destruction.30

With borrower delinquencies increasing, home prices began to falland investors grew suspicious of securitized mortgage bonds as in-vestments.31 The music stopped, leaving investment banks holdingboth the securities they maintained in their portfolios and those

How Did It Happen and How Will It End?, J. STRUCTURED FIN., Summer 2007, at 13,14–15; Souphala Chomsisengphet & Anthony Pennington-Cross, The Evolution ofthe Subprime Mortgage Market, 88 FED. RES. BANK ST. LOUIS REV. 31 (2006); MICHAEL

LEWIS, THE BIG SHORT: INSIDE THE DOOMSDAY MACHINE 28 (2010).26. See Jane Birnbaum, The Affluent, Too, Couldn’t Resist Adjustable Rates,

N.Y. TIMES, Mar. 20, 2008, http://www.nytimes.com/2008/03/20/business/20mortgage.html. “Today’s ARMs were ‘designed to fail, so you have to refi-nance . . . . It shouldn’t be surprising that values go up and down in this kind ofsituation. And when you most need to refinance you can’t — the crux of thecrunch.’” Id. (quoting Susan M. Wachter, Professor, Univ. of Pa.).

27. JOHNSON & KWAK, supra note 4, at 128; see MARK ZANDI, FINANCIAL SHOCK:A 3601/4 LOOK AT THE SUBPRIME MORTGAGE IMPLOSION, AND HOW TO AVOID THE

NEXT FINANCIAL CRISIS 95 (2009).28. JOHNSON & KWAK, supra note 4, at 130.29. See Vikas Bajaj & Louise Story, Mortgage Crisis Spreads Past Subprime Loans,

N.Y. TIMES, Feb. 12, 2008, at A1, available at http://www.nytimes.com/2008/02/12/business/12credit.html?pagewanted=1&_r=1 (noting difficulty borrowers haverefinancing “[a]s home prices fall and banks tighten lending standards”).

30. Jennifer E. Bethel, Allen Ferrell & Gang Hu, Law and Economic Issues inSubprime Litigation 19 (Harvard: John M. Olin Ctr. for Law, Econ., and Bus., Discus-sion Paper No. 612, 2008), available at http://www.law.harvard.edu/programs/olin_center/papers/pdf/Ferrell_et_al_612.pdf.

31. Wall Street and the Financial Crisis: The Role of High Risk Home Loans, HearingBefore the S. Subcomm. on Investigations (2010) (statement of Sen. Carl Levin), availa-ble at http://levin.senate.gov/newsroom/release.cfm?id=323765 (“‘[R]elaxedcredit guidelines, breakdowns in manual underwriting processes, and inexperi-enced subprime personnel . . . coupled with a push to increase loan volume andthe lack of an automated fraud monitoring tool’ led to deteriorating loans.”).



they had recently constructed for sale to what had become skittishinvestors.32 With no one to buy these assets, bank balance sheetsturned toxic.33 These toxic assets produced the credit freeze of thefall of 2008,34 which turned the collapse of the subprime mortgagemarket into a full-blown financial crisis.35 At the heart of thebroader financial crisis is a foreclosure crisis, with a national delin-quency rate hovering around 10%.36

This well-worn history, however, says little about how economicand social inequality might have helped to precipitate this crisis.What role, if any, did inequality play in the lead up to the foreclo-sure crisis? For an exploration of this issue, and in an attempt totease out potential causes of the foreclosure crisis itself, this Articleturns next to a detailed overview of the present state of that crisis.

B. The Present Foreclosure Crisis

In order to address the role that social inequality may haveplayed in the present financial crisis, an overview of the presentstate of the foreclosure crisis is in order. Since different states havedifferent foreclosure and delinquency rates, an analysis of these dif-ferent rates by state may reveal some of the qualities of those statesand how those qualities might explain some of the root causes ofthe foreclosure crisis within those states. One quality analyzed is theextent to which states have different types of social inequality, both

32. See LAWRENCE G. MCDONALD & PATRICK ROBINSON, A COLOSSAL FAILURE

OF COMMON SENSE: THE INSIDE STORY OF THE COLLAPSE OF LEHMAN BROTHERS 270,287 (2009).

33. John Parry, Next Up - Bear Stearns Portfolio Value a Litmus Test for Bonds,REUTERS (July 2, 2008), http://www.reuters.com/article/idUSN0148556720080702?pageNumber=1 (“Markets for many of these investments . . . deteriorated furtheras the outlook for U.S. housing . . . worsened and investors [saw] banks and hedgefunds continuing to unload risky assets from balance sheets.”).

34. See Jeannine Aversa, Banks Borrow Record Amount from Fed, USA TODAY

(Oct. 24, 2008), http://www.usatoday.com/money/economy/2008-10-24-483413484_x.htm (discussing increase in bank borrowing from Fed because of investorflight).

35. See Cox et al., supra note 21 (“Since banks did not know what banks heldtoxic assets . . . it became impossible to tell what banks were going to be able to payback loans. The credit freeze thus resulted in a drastic reduction in lending . . . .Thus commenced the global financial crisis.”). For a detailed description of theheight of the financial crisis in September 2008, see generally ANDREW ROSS

SORKIN, TOO BIG TO FAIL: THE INSIDE STORY OF HOW WALL STREET AND WASHING-

TON FOUGHT TO SAVE THE FINANCIAL SYSTEM — AND THEMSELVES (2009).36. See Press Release, Mortgage Bankers Ass’n, Delinquencies and Foreclo-

sure Starts Decrease in Latest MBA National Delinquency Survey (Aug. 26, 2010),available at http://www.mortgagebankers.org/NewsandMedia/PressCenter/73799.htm.



economic and racial. This analysis may shed light on the extent towhich social inequality may have fed into the current foreclosurecrisis afflicting community after community throughout the UnitedStates.

Any discussion of the foreclosure crisis should begin with asnapshot of the residential real estate market in the U.S. There areapproximately seventy-five million owner-occupied residentialproperties in the United States.37 About 70% of those, roughly fifty-two million properties, have outstanding mortgages on them.38 Ofthose, roughly one in seven, nearly eight million, are presently insome stage of the foreclosure process, or are at least thirty days de-linquent on a mortgage payment.39 Furthermore, one in five mort-gaged properties are presently “underwater”—that is, the ownerowes more on the mortgage than the property is worth.40 The suc-cess of efforts to curb the wave of foreclosures has proven elusive.As of the end of November 2010, nearly 550,000 borrowers had en-tered into permanent modifications through the Obama Adminis-tration’s loan modification efforts.41 The map below shows ingraphic form the state of foreclosures across the United States.

37. Selected Housing Characteristics: 2006-2008, U.S. CENSUS BUREAU, http://factfinder.census.gov/ (select “Data Sets”; then “American Community Survey”;then “2006-2008 American Community Survey 3-Year Estimates”; then “DataProfiles”; then “Show Result”) (last visited Dec. 10, 2010).

38. Id.39. E. Scott Reckard, Foreclosures Will Keep Rising Through 2010, Report Says,

L.A. TIMES, Nov. 20, 2009, at B1, available at http://articles.latimes.com/2009/nov/20/business/la-fi-mortgage-defaults20-2009nov20.

40. Jonathan Stempel, One in Five U.S. Mortgage Borrowers are Underwater,REUTERS, Mar. 4, 2009, http://www.reuters.com/article/idUSN0349273420090304. For a discussion of the social norms that prevent borrowers from engagingin “strategic default” when outstanding principal on a mortgage is higher than thevalue of the underlying property, see Brent T. White, Underwater and Not WalkingAway: Shame, Fear and the Social Management of the Housing Crisis (Ariz. Legal Studies,Discussion Paper No. 09-35, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1494467.

41. U.S. DEP’T OF THE TREASURY, MAKING HOME AFFORDABLE PROGRAM: SER-

VICER PERFORMANCE REPORT THROUGH NOVEMBER 2010 (2010), available at http://www.treasury.gov/initiatives/financial-stability/results/MHA-Reports/Documents/Nov%202010%20MHA%20Report.pdf.



Table 1: U.S. Map by Delinquency Activity42

June 2010 Foreclosure Rate Heat Map

The foreclosure crisis affects not only those saddled with debtthey cannot afford. Loss of home value due to foreclosures impactsthe prices of homes in a neighborhood considerably, with estimatessuggesting that foreclosures reduce the property values of homes inclose proximity to the foreclosed property (as far away as oneeighth of a mile) from .9% to 1.3% for each foreclosure.43 In 2009alone, one estimate concluded that U.S. homeowners would lose a

42. National Real Estate Trends: June 2010 Foreclosure Rate Heat Map,REALTYTRAC, http://www.realtytrac.com/trendcenter/default.aspx (last visited July28, 2010).

43. A number of studies estimate the costs of foreclosures on neighborhoodsand surrounding properties. Immergluck and Smith conducted a study in 2006,examining foreclosures in Chicago from 1997 and 1998, using data originally col-lected by the Illinois Department of Revenue. See Dan Immergluck & Geoff Smith,The External Costs of Foreclosure: The Impact of Single-Family Mortgage Foreclosures onProperty Values, 17 HOUSING POL’Y DEBATE 57, 58 (2006). They concluded that“each conventional foreclosure within an eighth of a mile of a single-family homeresults in a 0.9 percent decline in the value of that home.” Id. They also foundthat, “for the entire city of Chicago, the 3,750 foreclosures that occurred in 1997and 1998 are estimated to have reduced nearby property values by more than $598million, or an average of $159,000 per foreclosure.” Id.



combined $500 billion in wealth due to the loss of home value as adirect result of neighboring foreclosures in just that year.44 Further-more, it is estimated that before the crisis is over, American home-owners will have lost nearly $2 trillion in the value of their homes.45

Falling home prices reduce the local tax base, starving localities ofrevenue at a time when they are desperate for funds and when fore-closed and warehoused properties actually require greater munici-pal services, like police and fire protection.46

The foreclosure crisis is adversely impacting certain communi-ties more than others. Certain states, such as Florida, Nevada, Ari-zona, California, Illinois and Michigan, have been hit the hardest.47

Are there ways to explain these differences with reference to macro-or microeconomic trends? Some states, such as California and Flor-ida, experienced a large upswing in property values before propertyvalues declined significantly, resulting in an increased number of

A 2008 study by Harding, Rosenblatt, and Yao, using data from thirty-sevenMetropolitan Statistical Areas (MSAs) and thirteen states, showed “that foreclosedproperties within 300 feet of the subject property create[d] a negative externalityeffect of approximately 1.3% per distressed property. This contagion discount di-minished rapidly with distance and [fell] to .6% at a distance of 500 feet and be-yond.” JOHN P. HARDING, ERIC ROSENBLATT & VINCENT W. YAO, THE CONTAGION

EFFECT OF FORECLOSED PROPERTIES 14, 20 (2008), available at http://ssrn.com/ab-stract=1160354; see also John Y. Campbell et al., Forced Sales and House Prices (Nat’lBureau of Econ. Research, Working Paper No. 14866, 2009) (studying foreclosuresin Massachusetts and reaching similar findings as Harding et al.), available athttp://ssrn.com/abstract=1376188.

44. CTR. FOR RESPONSIBLE LENDING, SOARING SPILLOVER: ACCELERATING FORE-

CLOSURES TO COST NEIGHBORS $502 BILLION IN 2009 ALONE; 69.5 MILLION HOMES

LOSE $7,200 ON AVERAGE 1 (2009), available at http://www.responsiblelending.org/mortgage-lending/research-analysis/soaring-spillover-3-09.pdf. The Centerfor Responsible Lending (CRL) used the estimate from the 2008 study of Hardinget al. that a 0.744% home value decline occurs for each foreclosure within one-eighth of a mile. Id. at 2. The national results reported by the CRL were for 56,777census tracts or similar geographies and only included counties located in MSAs.Id. The CRL outlined the foreclosure spillover by state, including data for 2009foreclosures and anticipated foreclosures from 2009 to 2012. Id. at 3.

45. The CRL estimated that “[o]ver the next four years, foreclosures will af-fect 91.5 million nearby homes, reducing property values $1.86 trillion in total, or$20,300 per household.” Id. at 2.

46. William C. Apgar & Mark Duda, Collateral Damage: The Municipal Impact ofToday’s Mortgage Foreclosure Boom, HOMEOWNERSHIP PRESERVATION FOUNDATION, 6–7(May 11, 2005), http://www.995hope.org/content/pdf/Apgar_Duda_Study_Short_Version.pdf.

47. The delinquency rates for these five states are as follows: Florida(20.43%), Nevada (19.04%), Arizona (13.20%), California (12.49%), Illinois(11.23%), and Michigan (11.13%). MORTGAGE BANKERS ASS’N, NATIONAL DELIN-

QUENCY SURVEY 4 (2010) [hereinafter MBA DATA], available at http://me-dia.oregonlive.com/frontporch/other/NDS_Q409.pdf.



underwater properties.48 But other high-priced markets that exper-ienced large increases in property values have not had similarlyhigh foreclosure or delinquency rates. For example, in New YorkCity, the first quarter of 2010 saw only 164 foreclosure starts in Man-hattan, where home values skyrocketed in the last decade.49

Unemployment likely has also played a role in many markets.Unemployment is high in Michigan and Ohio,50 where a substantialpercentage of both states’ residential properties are facing delin-quency and entering foreclosure, particularly in cities.51 But thereis also high unemployment in Mississippi and South Carolina,which are not experiencing the same sort of delinquencies andforeclosures as some of the hardest hit states.52

While there is no doubt that price fluctuations and unemploy-ment are driving delinquencies and foreclosures, there are alsoother forces at work. In the following section, I will address the in-terplay between income inequality and financial crises. This reviewreveals that there appears to be a correlation between social ine-quality and the incidence of foreclosures presently plaguing thestates.

48. STANDARD & POOR’S, S&P/CASE-SHILLER HOME PRICE INDICES 2008, A YEAR

IN REVIEW 5 (2009), available at http://www2.standardandpoors.com/spf/pdf/in-dex/Case-Shiller_Housing_Whitepaper_YearinReview.pdf (“The area traditionallydefined as the Sun Belt — Arizona, California, Florida and Nevada — clearly hadboth the largest run-up in prices since 2000 and has been the hardest hit in thedownturn.”).

49. Constance Mitchell Ford, City Foreclosures Climb in First Quarter, WALL ST. J.,May 21, 2010, at A21, available at http://online.wsj.com/article/SB10001424052748703559004575256573362821934.html?mod=rss_newyork_main. New York Cityalso experienced a drop in property values. See Press Release, Standard and Poor’s,Home Prices in the New Year Continue the Trend Set in Late 2009 According tothe S&P/Case-Shiller Home Price Indices 3 (Mar. 30, 2010), available at http://www.standardandpoors.com/spf/CSHomePrice_Release_033056.pdf. This dropcontinued into the second quarter. See James Comtois, NY-Area Home Prices Back to2004 Levels, CRAIN’S NEW YORK BUSINESS.COM (Aug. 9, 2010, 1:25 PM), http://www.crainsnewyork.com/article/20100809/REAL_ESTATE/100809846.

50. Press Release, U.S. Dep’t of Labor: Bureau of Labor Statistics, Regionaland State Employment and Unemployment (June 18, 2010) (on file with author).The most recent unemployment numbers are available at http://www.bls.gov/news.release/laus.nr0.htm.

51. See MBA DATA, supra note 47, at 4.52. See U.S. DEP’T OF LABOR: BUREAU OF LABOR STATISTICS, supra note 50;

MBA DATA, supra note 47, at 4.



II.INEQUALITY AND FINANCIAL CRISES

A. On Game Theory, Trust, and Social Distance

Table 2 is a timeline of the share of total income enjoyed bythe wealthiest 10% of the population in the U.S. over the last ninetyyears. This share was remarkably high in both the lead up to theGreat Depression and the years preceding the Great Recession.

Table 2: Share of Total Income Going to Top 10%53

53. Emmanuel Saez, Econometrics Laboratory Software Archive at theUniversity of California, Berkeley, Striking it Richer: The Evolution of Top Incomes inthe United States (Update with 2007 Estimates), 6 fig.1 (Aug. 5, 2009), http://elsa.berkeley.edu/~saez/saez-UStopincomes-2007.pdf.



If the past is prologue, one might guess that some event orshock similar to that which occurred near the left hand side of thetime line might occur again when this indicator rises again. Simi-larly, as Table 3 reveals, income inequality, as measured using theGINI Coefficient,54 also shows that income inequality has generallyincreased in the United States since about the early 1970s, reachinglevels in the middle of this decade similar to those seen immedi-ately prior to the Great Depression.

54. The U.S. Central Intelligence Agency describes the GINI coefficient asfollows:

This index measures the degree of inequality in the distribution of family in-come in a country. The index is calculated from the Lorenz curve, in whichcumulative family income is plotted against the number of families arrangedfrom the poorest to the richest. The index is the ratio of (a) the area betweena country’s Lorenz curve and the 45 degree helping line to (b) the entiretriangular area under the 45 degree line. The more nearly equal a country’sincome distribution, the closer its Lorenz curve to the 45 degree line and thelower its Gini index, e.g., a Scandinavian country with an index of 25. Themore unequal a country’s income distribution, the farther its Lorenz curvefrom the 45 degree line and the higher its Gini index, e.g., a Sub-Saharancountry with an index of 50. If income were distributed with perfect equality,the Lorenz curve would coincide with the 45 degree line and the index wouldbe zero; if income were distributed with perfect inequality, the Lorenz curvewould coincide with the horizontal axis and the right vertical axis and theindex would be 100.

Cent. Intelligence Agency, The World Factbook: Distribution of Family Income - GINIIndex, THE WORLD FACTBOOK, https://www.cia.gov/library/publications/the-world-factbook/fields/2172.html (last visited July 29, 2010). A range of societal illsare linked to having a high GINI coefficient, e.g., poor public health outcomesand civil unrest, to name just two. See U.N. COMM. FOR DEV. POL’Y, IMPLEMENTING

THE MILLENNIUM DEVELOPMENT GOALS: HEALTH INEQUALITY AND THE ROLE OF

GLOBAL HEALTH PARTNERSHIPS, at 4, 10, U.N. Sales No. E.09.II.A.2 (2009), availableat http://www.un.org/esa/policy/devplan/cdppublications/2009cdp_mdghealth.pdf (finding that “when income distribution becomes more unequal, health ine-quality worsens”); Craig Bradford, Effects of Globalization on Income Inequality in HighIncome Countries, 2 BRYANT ECON. RES. PAPER 7, Spring 2009, at 7, available at http://web.bryant.edu/~economix/Research%20Papers/Vol%202/Vol%202%20No%202%20Bradford.pdf. See generally Patrick M. Regan & Daniel Norton, Greed,Grievance, and Mobilization in Civil Wars, 49 J. CONFLICT RESOL. 319 (2005), availableat http://jcr.sagepub.com/content/49/3/319.full.pdftml (finding that“[r]esource distribution—as indicated by the extent of political discrimination—isone of the strongest predictors of the onset of violent forms of antistate activity”).



Table 3: GINI Timeline55

55. For estimated 1929 data, see Eugene Smolensky & Robert Plotnick,Inequality and Poverty in the United States: 1900 to 1990, at 6 fig.2, 8–9 (Univ. of Wis.-Madison, Inst. for Res. on Poverty, Discussion Paper No. 998-93, 1993). Theauthors explain that by utilizing income tax return data from the period,identifying the relationship for 1947 through 1989 (using the concrete GINI data),and then projecting backwards, they were able to obtain the GINI ratios for thefirst half of the century. Id. at 8–9; see also Edward C. Budd, Introduction toPROBLEMS OF THE MODERN ECONOMY: INEQUALITY AND POVERTY xiii tbl.1 (Edward C.Budd ed., 1967) (citations omitted). The 1929 data was obtained from a 1958article which used figures generated by the Brookings Institution. Id. at xiii n.2;Selma F. Goldsmith, The Relation of Census Income Distribution Statistics to Other IncomeData, in 23 NAT’L BUREAU OF ECON. RES., AN APPRAISAL OF THE 1950 CENSUS

INCOME DATA 63, 92–94 (1958), available at http://www.nber.org/chapters/c1050.pdf. The Institution combined a number of different income statistics forpersons and then converted those statistics to a family-unit basis. Id. at 94. Theyalso utilized data from federal individual income tax returns. Id. Goldsmithadjusted the figures from the Brookings Institution to remove capital gains andlosses from her 1929 figure. Id. “The adjustments were necessarily rough, but theyserve to make the estimates for 1929 more comparable with those for recent yearsand thereby make it possible to avoid some mistaken conclusions drawn by [those]who compared postwar income distributions directly with the Brookings figures.”Id. For 1929 to 1962 data, see Budd, supra, at xiii tbl.1. For 1967 to 2008 data, seeU.S. CENSUS BUREAU, SELECTED MEASURES OF HOUSEHOLD INCOME DISPERSION:1967–2008, at 1–2 tbl.A-3, available at http://www.census.gov/hhes/www/income/data/historical/inequality/IE-1.pdf; see also Arthur F. Jones Jr. & Daniel H.Weinberg, U.S. CENSUS BUREAU, P60-204, THE CHANGING SHAPE OF THE NATION’SINCOME DISTRIBUTION: 1947–1998 (2000), available at http://www.census.gov/prod/2000pubs/p60-204.pdf. The GINI coefficient for 2009 was virtually



Comparing international GINI scores, in 2008 the UnitedStates came in relatively high at 0.466 in money income, or 0.451 inequivalence-adjusted income.56 That is, the United States has rela-tively high income inequality, scoring just above Ghana and Turk-menistan, and just below Senegal and Cambodia.57

As former Secretary of Labor under President Clinton, RobertReich, recently explained:

Consider: in 1928 the richest 1 percent of Americans received23.9 percent of the nation’s total income. After that, the sharegoing to the richest 1 percent steadily declined. New Deal re-forms, followed by World War II, the GI Bill and the Great So-ciety expanded the circle of prosperity. By the late 1970s thetop 1 percent raked in only 8 to 9 percent of America’s totalannual income. But after that, inequality began to widen again,and income reconcentrated at the top. By 2007 the richest 1percent were back to where they were in 1928—with 23.5 per-cent of the total.58

Even David Stockman, director of the Office of Managementand Budget under President Reagan, in an op-ed piece recentlypenned for the New York Times, raised concerns about growingincome inequality and its impact on markets:

It is not surprising, then, that during the last bubble (from2002 to 2006) the top 1 percent of Americans — paid mainly

unchanged from 2008. Carmen DeNavas-Walt et al., U.S. CENSUS BUREAU, P60-238,INCOME, POVERTY AND HEALTH INSURANCE COVERAGE IN THE UNITED STATES: 2009,at 4–5 (2010), available at http://www.census.gov/prod/2010pubs/p60-238.pdf.

56. CARMEN DENAVAS-WALT ET AL., U.S. CENSUS BUREAU, P60-236, INCOME,POVERTY, AND HEALTH INSURANCE COVERAGE IN THE UNITED STATES: 2008, at 10(2009), available at http://www.census.gov/prod/2009pubs/p60-236.pdf.

57. See KEVIN WATKINS ET AL., U.N. DEV. PROGRAMME, Human Development Re-port 2007/2008, at 281–83 (2007), available at http://hdr.undp.org/en/media/HDR_20072008_EN_Complete.pdf. The GINI coefficients used by the U.N. re-flected GINI data for different years for each country, based on the data availableat the time the report was issued. Id. The countries were then ranked according tothe human development index (a “composite index that measures the averageachievements in a country in three basic dimensions of human development: along and healthy life; access to knowledge; and a decent standard of living”), notby GINI indexes. Id. at 225. Using the most recent data available, in 2006 the U.S.’sGINI coefficient actually increased to .464. See BRUCE H. WEBSTER JR. & ALEMAYEHU

BISHAW, U.S. CENSUS BUREAU, ACS-08, INCOME, EARNINGS, AND POVERTY DATA FROM

THE 2006 AMERICAN COMMUNITY SURVEY 10–11 (2007), available at http://www.census.gov/prod/2007pubs/acs-08.pdf. Applying this number to the 2008 re-port, the U.S. would actually rank 19 spots higher (i.e., worse—with greater in-come inequality) than presently reflected in the U.N. report.

58. Robert Reich, Unjust Spoils, THE NATION, July 19, 2010, available at http://www.thenation.com/article/36893/unjust-spoils.



from the Wall Street casino — received two-thirds of the gainin national income, while the bottom 90 percent — mainly de-pendent on Main Street’s shrinking economy — got only 12percent. This growing wealth gap is not the market’s fault. It’sthe decaying fruit of bad economic policy.59

Why concern ourselves with economic inequality, though?Speaking generally, Wilkinson and Pickett, in their recent book TheSpirit Level, show that, globally, income inequality correspondsstrongly with a range of societal ills.60 By creating an index of thesesocietal problems, such as crime rates, and measuring them againstincome inequality, the authors find that nations with higher in-come inequality have the greatest prevalence of these social ills.61

State-by-state analysis in the U.S. yields a similar pattern, as Table 4indicates.

59. David Stockman, Four Deformations of the Apocalypse, N.Y. TIMES, July 31,2010, at WK9, available at http://www.nytimes.com/2010/08/01/opinion/01stockman.html?pagewanted=1&ref=opinion.

60. RICHARD WILKINSON & KATE PICKETT, THE SPIRIT LEVEL: WHY GREATER

EQUALITY MAKES SOCIETIES STRONGER (2009). For a critique of The Spirit Level, to-gether with the Authors’ response to the critique, see Christopher Snowdon, 20Questions for Richard Wilkinson & Kate Pickett, THE SPIRIT LEVEL DELUSION: FACT-CHECKING THE LEFT’S NEW THEORY OF EVERYTHING (July 29, 2010), http://spir-itleveldelusion.blogspot.com/2010/04/20-questions-for-richard-wilkinson-kate.html.

61. This Author makes no claim that the data presented in this graph exposesany causal connection between inequality and the societal problems Wilkinson andPickett studied and made a part of this index.



Table 4: State-by-State Spirit Level Scores62

A graph with a trend line like this indicates a possible positivecorrelation between the data represented on the two axes. Here,scoring high on the Wilkinson and Pickett index of social problemscorrelates with having high income inequality.

But what relationship, if any, does economic inequality havewith financial crises? In his seminal work on the Great Depression,Galbraith pointed to the severe income inequality in the UnitedStates—what he called the “bad distribution of income”—as one ofthe five “weaknesses” in the economy that “had an especially inti-mate bearing on the ensuing disaster.”63

In 1929 the rich were indubitably rich. The figures are not en-tirely satisfactory, but it seems certain that the 5 per cent of thepopulation with the highest incomes in that year received ap-proximately one third of all personal income. The proportionof personal income received in the form of interest, dividends,and rent — the income, broadly speaking, of the well-to-do —was about twice as great as in the years following the SecondWorld War.64

62. WILKINSON & PICKETT, supra note 60, at 22 fig.2.4.63. JOHN KENNETH GALBRAITH, THE GREAT CRASH 1929, at 177 (1997).64. Id. Galbraith explained the impact of this imbalance on consumer spend-

ing as follows:



Another view on income inequality comes from Bruce Judsonof the Yale School of Management. According to Judson, rising in-come inequality creates a “governance problem.”65 This govern-ance problem begins with the wealthy developing a “sense ofentitlement” and insulating themselves from society.66 They then:

become less dependent on public services and less connectedto the concerns of the rest of society . . . . [T]his leads the bulkof those in the top income strata to oppose tax increases thatwould fund enhanced public amenities . . . . [T]hey use theirwealth to obtain political influence that solidifies theirprivileges.67

Teddy Roosevelt, discussing the need for an estate tax, de-scribed the corrosive effect of income inequality on the politicalprocess as follows:

The absence of effective State, and, especially, national, re-straint upon unfair money-getting has tended to create a smallclass of enormously wealthy and economically powerful men,whose chief object is to hold and increase their power. Theprime need is to change the conditions which enable thesemen to accumulate power which is not for the general welfarethat they should hold or exercise.68

Turning to the present financial crisis, as a description of theforces at work in the lead up to the financial crisis, Judson’s the-ory—and Roosevelt’s fears—would seem to apply. If one traces therecent rise in income inequality in the U.S. over the last forty years,it corresponds with two phenomena: (1) a greater share of the ris-ing income of the wealthy going to the financial sector, and (2) a

This highly unequal income distribution meant that the economy was depen-dent on a high level of investment or a high level of luxury consumer spend-ing or both. The rich cannot buy great quantities of bread. If they are todispose of what they receive it must be on luxuries or by way of investment innew plants and new projects. Both investment and luxury spending are sub-ject, inevitably, to more erratic influences and to wider fluctuations than thebread and rent outlays of the $25-a-week workman. This high-bracket spend-ing and investment was especially susceptible, one may assume, to the crush-ing news from the stock market in October of 1929.

Id. at 177–78. For a further discussion of the economic distortions caused by theconcentration wealth among top earners, see ROBERT B. REICH, AFTERSHOCK: THE

NEXT ECONOMY AND AMERICA’S FUTURE 32–38 (2010).65. BRUCE JUDSON, IT COULD HAPPEN HERE: AMERICA ON THE BRINK 77 (2009).66. Id.67. Id.68. Theodore Roosevelt, The New Nationalism, Speech at John Brown Memo-

rial Park (Aug. 31, 1910), available at http://www.theodore-roosevelt.com/images/research/speeches/trnationalismspeech.pdf.



push towards deregulation of the financial sector in the service ofgreater profits. As stated earlier, rising income inequality in theUnited States commenced in the late 1970s and a disproportionateshare of that income was ceded to households earning their incomein the financial sector. In 1978, average banker compensation wason par with pay in the private sector overall. By 2007, it was morethan twice that of the average private sector employee.69 Moreover,since the 1970s, a disproportionate share of profits, in relation togross domestic product, has gone to the financial sector.70

This rising share of income for the financial sector corre-sponds with the era of financial deregulation that began in the1980s. That era brought about laws and policies that accomplisheda range of “innovations”: lifting interest rate caps on mortgages,which ushered in the creation of subprime mortgage products;71

permitting investment banks to take on more debt, lowering mar-gin requirements;72 preempting state anti-predatory lending lawsthat allowed a wide range of banking entities to operate with lightfederal regulation despite state efforts to rein in risky lending;73

lowering the wall between investment banks and commercial banksthrough the repeal of the Glass-Steagall Act;74 and prohibiting theregulation of derivatives through passage of the Commodity Fu-

69. JOHNSON & KWAK, supra note 4, at 60–61 (citation omitted).70. John Bellamy Foster & Fred Magdoff, Financial Implosion and Stagnation:

Back to the Real Economy, MONTHLY REV., Dec. 2008, at 12 chart 2 (citation omitted),available at http://www.monthlyreview.org/081201foster-magdoff.php.

71. Depository Institutions Deregulation and Monetary Control Act of 1980,12 U.S.C. § 226 (2006).

72. For a description of the SEC’s efforts permitting certain investment banksto increase their leverage, see Stephen Labaton, Agency’s ‘04 Rule Let Banks Pile UpNew Debt, N.Y. TIMES, Oct. 3, 2008, at A1, available at http://www.nytimes.com/2008/10/03/business/03sec.html; Joseph E. Stieglitz, Capitalist Fools, VANITY FAIR,Jan. 2009, at 48. For a description of the risks of increased leverage on the financialsystem, see Eric S. Rosengren, President & CEO Fed. Reserve Bank of Bos., Could aSystemic Regulator Have Seen the Current Crisis?, Before the 10th Seoul Interna-tional Financial Forum (Apr. 5, 2009), available at http://www.bos.frb.org/news/speeches/rosengren/2009/041509.pdf.

73. For a description of federal bank regulators’ efforts to preempt state anti-predatory lending laws, see Julia Patterson Forrester, Still Mortgaging the AmericanDream: Predatory Lending, Preemption, and Federally Supported Lenders, 74 U. CIN. L.REV. 1303, 1339–49 (2006); Christopher L. Peterson, Federalism and Predatory Lend-ing: Unmasking the Deregulatory Agenda, 78 TEMP. L. REV. 1, 68–84 (2005).

74. On the connection between the repeal of the Glass-Steagall Act and thefinancial crisis, see Joseph Karl Grant, What the Financial Services Industry Puts To-gether Let No Person Put Asunder: How the Gramm-Leach-Bliley Act Contributed to the2008-2009 American Capital Markets Crisis, 73 ALB. L. REV. 371 (2010).



tures Modernization Act.75 In the words of Simon Johnson andJames Kwak: “The Wall Street banks are the new American oligar-chy—a group that gains political power because of its economicpower, and then uses that political power for its own benefit.”76

These commentators describe the power of the financial sector dueto its growing share of income as follows:

The unprecedented amounts of money flowing through the fi-nancial sector, increasingly concentrated in a handful ofmegabanks, were the foundation of the new financial oligar-chy . . . . Wall Street used an arsenal of other, completely legalweapons in its rise to power. The first was traditional capital:money, which yielded its influence directly via campaign con-tributions and lobbying expenses. The second was human capi-tal: the Wall Street veterans who came to Washington to shapegovernment policy and shape a new generation of civil ser-vants. The third, and perhaps most important, was cultural cap-ital: the spread and ultimate victory of the idea that a large,sophisticated financial sector is good for America.77

And the banks did not stop throwing their financial weightaround once the financial crisis hit; to the contrary, their lobbyingreached a fevered pitch. According to one study, the six largestbanks and their trade associations spent nearly $600 million lobby-ing Congress on financial reform.78 Moreover, some companies,like AIG, continued to devote resources to lobbying even after re-ceiving federal bailout funds,79 and some, like Bank of America,

75. Commodity Futures Modernization Act of 2000, 7 U.S.C. §§ 1-27f (2006).For a description of the passage of the CFMA, see JUDSON & KWAK, supra note 4, at9. For a description of the role of credit default swaps, a form of derivative, inpromoting risky lending practices during the build up to the financial crisis, seeRICHARD A. POSNER, A FAILURE OF CAPITALISM: THE CRISIS OF ‘08 AND THE DESCENT

INTO DEPRESSION 56–60 (2009).76. JOHNSON & KWAK, supra note 4, at 6.77. Id. at 89–90. For a further description of how this “governance problem”

may have played out in the transformation of the U.S. economy over the last fortyyears, see JACOB S. HACKER & PAUL PIERSON, WINNER-TAKE-ALL POLITICS: HOW

WASHINGTON MADE THE RICH RICHER—AND TURNED ITS BACK ON THE MIDDLE

CLASS 66–72 (2010).78. KEVIN CONNOR, INST. FOR AMERICAN’S FUTURE, BIG BANK TAKEOVER: HOW

TOO-BIG-TO-FAIL’S ARMY OF LOBBYISTS HAS CAPTURED WASHINGTON 5 (2010), availa-ble at http://www.ourfuture.org/files/documents/big-bank-takeover-final.pdf.

79. Elizabeth Williamson, AIG Still Lobbies to Relax Oversight Rules: After Receiv-ing Federal Aid, Insurer Focuses on Laws Aimed at Keeping Tabs on Mortgage Originators,WALL ST. J., Oct. 16, 2008, at A6, available at http://online.wsj.com/article_email/SB122409634988737247-lMyQjAxMDI4MjE0NjAxOTY2Wj.html.



actually increased such expenditures after receiving bailout assis-tance from the federal government.80

It is hard to argue that a “governance problem” does not lie atthe heart of the connection between financial sector influence, der-egulation, and the financial crisis. Lifting many of the constraintson the financial sector created a shadow banking system that oper-ated without a net (at least one that was not taxpayer financed),taking on greater and greater risk, and operating with little over-sight.81 The practices that deregulation authorized—excessive lev-erage, an unregulated market in derivatives, exotic mortgageproducts—were at the center of an interconnected and overex-tended financial sector, a sector that ultimately collapsed under itsown weight.82 While the governance problem seems to explain agreat deal, it may not be the only potential connection betweenrising income inequality and this financial crisis.

An alternate theory that may explain this connection comesfrom former International Monetary Fund economist, now at theUniversity of Chicago, Raghuram Rajan, who posits that growingeconomic inequality in the United States led to the present finan-cial crisis because politicians used easy access to credit to mollifypeople of low income, in an effort offset the possibility of discon-tent that might arise from growing inequality.83 He argues that this

80. Paul Kiel, Bailed-Out Companies Spend Millions to Lobby Congress, PROPUBLICA

(July 22, 2009), http://www.propublica.org/article/bailed-out-companies-spend-millions-to-lobby-congress.

81. For a discussion of the interplay between de-regulation and the financialcrisis, see Todd J. Zywicki & Joseph D. Adamson, The Law and Economics of SubprimeLending, 80 U. COLO. L. REV. 1, 5–7 (2009); Sally Pittman, Comment, ARMs, But NoLegs to Stand on: “Subprime” Solutions Plague the Subprime Mortgage Crisis, 40 TEX.TECH L. REV. 1089, 1093–94 (2008); Patricia A. McCoy & Elizabeth Renuart, TheLegal Infrastructure of Subprime and Nontraditional Home Mortgages, in BORROWING TO

LIVE: CONSUMER AND MORTGAGE CREDIT REVISITED 110 (Nicolas P. Retsinas & EricS. Belsky eds., 2008).

82. See Luis A. Aguilar, Commissioner, U.S. Sec. & Exch. Comm’n, Speech atCompliance Week 2010: Market Upheaval and Investor Harm Should Not be theNew Normal (May 24, 2010), available at http://www.sec.gov/news/speech/2010/spch052410laa-1.htm (stating that “[t]he financial crisis and its enormous costs tosociety were the direct result of years of deregulation . . . . This market breakdownand the difficulty in determining how and why it occurred are yet further starkreminders of the dangers of weak oversight of our tightly interconnected financialmarkets”).

83. RAGHURAM RAJAN, FAULT LINES: HOW HIDDEN FRACTURES STILL THREATEN

THE WORLD ECONOMY (2010). Rajan explains this phenomenon as follows: becauseit is hard to impact income disparities:

[P]oliticians have looked, or been steered into looking, for other, quickerways to mollify their constituents. We have long understood that it is not in-



push from elected officials is reflected in such laws as the Commu-nity Reinvestment Act (CRA)84 and the behavior of the Govern-ment-Sponsored Entities (GSEs), Fannie Mae and Freddie Mac.According to Rajan, the CRA and the affordable housing goals ofthe GSEs—promoted by Congress, and the Clinton and Bush Ad-ministrations—forced banks to make risky loans to unworthy bor-rowers.85 Similarly, the prevalence of risky lending in communitiesof color, as discussed below, has led some to blame those same com-munities for the financial crisis.86 This Article will return to theseand other arguments in Part III, infra. In that section, a review ofthe hard facts on these issues—for example, that 94% of the riskiestlending carried out during the inflation of the housing bubble tookplace beyond the reach of the CRA—renders such argumentsunconvincing.

A third potential explanation of the connection between finan-cial crises and social inequality is that social inequality increases so-cial distance. And increased social distance reduces trust within acommunity, which leads to non-cooperative and predatory con-duct.87 Adam Smith,88 John Stuart Mill,89 Kenneth Arrow,90

Amartya Sen,91 and Niall Ferguson92 extol the importance of trust

come that matters but consumption. Stripped to its essentials, the argument isthat if somehow the consumption of middle-class householders keeps up, ifthey can afford a new car every few years and the occasional exotic holiday,perhaps they will pay less attention to their stagnant monthly paychecks.

Id. at 8–9.84. 12 U.S.C. §§ 2901–08 (2006).85. RAJAN, supra note 83, at 32–45. For a description of the policies of the

Clinton and Bush Administrations in promoting so-called “affordable housinggoals” through the GSEs, see ALYSSA KATZ, OUR LOT: HOW REAL ESTATE CAME TO

OWN US (2009).86. See discussion infra Part II.C.87. See infra Part II.B.88. ADAM SMITH, AN INQUIRY INTO THE NATURE AND CAUSES OF THE WEALTH OF

NATIONS 292 (R.H. Campbell & A.S. Skinner eds., Oxford Univ. Press 1976)(describing importance of trust in extensions of credit and bank transactions).

89. JOHN STUART MILL, PRINCIPLES OF POLITICAL ECONOMY 111 (W.J. Ashleyed., new ed. 1909) (stressing importance of trust in “conjoint” human action).

90. Kenneth J. Arrow, Gifts and Exchanges, 1 PHIL. & PUB. AFFS. 343, 357(1972).

91. Amartya Sen, Adam Smith’s Market Never Stood Alone, FIN. TIMES, Mar. 11,2009, available at http://www.ft.com/cms/s/0/f8e0b1be-0ddc-11de-8ea3-0000779fd2ac.html (defending Adam Smith as offering a more nuanced view of capitalismthan those that assert he stood solely for unfettered free market, and affirmingthat “an economy needs other values and commitments such as mutual trust andconfidence to work efficiently”).

92. NIALL FERGUSON, THE ASCENT OF MONEY: A FINANCIAL HISTORY OF THE

WORLD 29–30 (2008) (describing money as “trust inscribed”).



in economic exchanges. It is difficult to engage in any economicactivity without trusting, at least to some degree, a counterparty’swillingness to honor their contracts; the currency system—that themoney changing hands is valid and redeemable; the financial sys-tem—that the method of payment can convey value; and the courtsand the legal system—that they will police and punish breaches oftrust. As Arrow posits, “Virtually every commercial transaction” hasan element of trust in it.93

Since trust is at the heart of cooperative economic exchange,does a lack of trust diminish the capacity for trusting, and raise theprospect of untrustworthy behavior? Furthermore, what are some ofthe forces that might diminish trust, and lead to a lack of trustwor-thiness? Research resulting from the prisoner’s dilemma and simi-lar games, as well as field studies, reveals that where there is greatersocial distance between game participants, participants are lesstrusting and each is more willing to take advantage of other partici-pants.94 For example, when studying rubber traders in Singaporeand Malaysia in the 1960s, Janet Landa unearthed a complex hier-archy of social relations among these traders.95 The extent to whicha trader trusted another trader depended on the level of social dis-tance between the two of them; those closest in kinship weretrusted more, and as social distance increased, trust decreased.96

93. Arrow, supra note 90, at 357.94. See, e.g., Elizabeth Hoffman et al., Social Distance and Other-Regarding Behav-

ior in Dictator Games, 86 AM. ECON. REV. 653, 658 (1996) (finding increase in non-cooperative behavior as social distance widens). Summarizing a body of researchon group dynamics, Elizabeth Chamblee Burch describes conduct within groups asfollows:

Group members exhibit other-regarding preferences—trust, reciprocity, andaltruism—toward other members. Their fairness considerations change basedon whether the situation involves another group member (inclusionary con-cerns) or individuals outside the group (exclusionary concerns). Cohesivegroup members are more likely to cooperate with one another and care aboutthe collective outcome, and less likely to exit the group when doing so bene-fits the individual rather than the group. These theory-based insights suggestthat group membership plays a pivotal role in attitude changes, particularlywhen group identity is salient and relevant to the attitudinal issue. Sharedhistories, implicit feedback, and trust, for example, offer insights aboutwhether individuals will cooperate or defect.

Elizabeth Chamblee Burch, Litigating Groups, 61 ALA. L. REV. 1, 17 (2009) (cita-tions omitted).

95. Janet T. Landa, A Theory of the Ethnically Homogeneous Middleman Group: AnInstitutional Alternative to Contract Law, 10 J. LEGAL STUD. 349, 350 (1981).

96. Id. at 352.



Like it or not, individuals trust those who they perceive to besimilar, whom they perceive as being members of the same group.97

At the same time, we are more prone to take advantage of individu-als who are less like us, whom we perceive to not share certain char-acteristics as ourselves.98

Since trust is critical to economic exchange, and a lack of trustcan make such exchange more difficult, is there a way to measurethe relative trust within a society or community? One commonlyaccepted way to measure the presence of trust in a community is toreview responses to the General Values Survey, which asks, amongmany other questions, whether “most people can be trusted.”99

Looking at responses to this question, in the U.S., generalized trusthas declined in recent years as income inequality has increased, asTable 5 indicates.

97. See studies cited infra note 98. The findings of the studies support theproposition “that levels of cooperation tend to be higher the stronger the ties be-tween actors in the exchange.” Nancy R. Buchan et al., Swift Neighbors and PersistentStrangers: A Cross-Cultural Investigation of Trust and Reciprocity in Social Exchange, 108AM. J. SOC. 168, 200 (2002) (citation omitted).

98. For a discussion of the relationship between social distance and coopera-tion, see Buchan et al., supra note 97; Iris Bohnet & Bruno S. Frey, The Sound ofSilence in Prisoner’s Dilemma and Dictator Games, 38 J. ECON. BEHAV. & ORG. 43(1999); Michael W. Macy & John Skvoretz, The Evolution of Trust and CooperationBetween Strangers: A Computational Model, 63 AM. SOC. REV. 638 (1998). As one com-mentator remarks:

Because we actively, and sometimes unconsciously, participate in the preserva-tion of our perceptions and preferences, situations of great conflict and socialdistance are especially troublesome. We perceive our enemies to be evil, dis-tant, strange, unapproachable, unfamiliar, distasteful, and unknowable. More-over, we actively resist any evidence to the contrary.

David Sally, Game Theory Behaves, 87 MARQ. L. REV. 783, 791 (2004) (citationomitted).

99. See C. MONICA CAPRA ET AL., ATTITUDINAL AND BEHAVIORAL MEASURES OF

TRUST: A NEW COMPARISON 1 (2008), available at https://www.gate.cnrs.fr/IMG/pdf/Capra.pdf. The finding of their study “supports the continued use of theGSS . . . questions to measure trust for policy purposes . . . .” Id. at 2.



Table 5: On Income Inequality and Trust100

The numbers on this chart indicate the level of trust in theU.S. in a given year in the late twentieth century, together with in-come inequality in those same years. Here we see a negative correla-tion: as income inequality has increased in the United States overthe last few decades, trust has declined.

If we believe inequality and social distance reduce cooperativebehavior and encourage rent-seeking, to what extent might the fi-nancial crisis bear such a theory out? Turning first to economic ine-quality, the theory suggests there would be less cooperativebehavior and higher incidents of predatory conduct in communi-ties in which there is higher income inequality.101 The followingsection addresses these questions.

100. ERIC M. USLANER, THE MORAL FOUNDATIONS OF TRUST 187 fig.6-6 (2002).The methodology used in creating this graph was fairly straightforward, comparingthe level of trust in the United States in a given year to the level of inequality inthat year, revealing an apparent correlation between the two. Id. Without more, noclaim that one causes the other is made by Uslaner or this Author.

101. There are obviously many bases for social distance. This paper focuseson the ways that two such bases appear to have played out in the lead up to thepresent financial crisis: social distance based on income and that based on race.For a discussion of gender and subprime lending, see NAT’L COUNCIL OF NEGRO

WOMEN, INCOME IS NO SHIELD, PART III, ASSESSING THE DOUBLE BURDEN: EXAMIN-

ING RACIAL AND GENDER DISPARITIES IN MORTGAGE LENDING (2009), available athttp://www.ncrc.org/images/stories/pdf/research/ncrc%20nosheild%20june%2009.pdf.



B. Income Inequality, Social Distance and the Foreclosure Crisis

If delinquency rates are one of the key symptoms of the finan-cial crisis and income inequality may lie at the heart of the financialcrisis, does a community’s level of economic inequality correspondto its delinquency rate?

As Table 6 reveals, there appears to be some correlation be-tween income inequality by state at the height of the subprimemortgage frenzy—2006, the last year in which such information isavailable from the U.S. Census Bureau—and present delinquencyrates by state.

Table 6: Income Inequality and Delinquency Rates by State102

102. Tables 6 through 9, 12, 13, and 15 were generated by the author. For theincome inequality data used, see WEBSTER JR. & BISHAW, supra note 57, at 11 tbl.5.For the delinquency rate data, see MBA DATA, supra note 47, at 4. Themeasurement of the statistical significance of this and the other author-generatedtables, the “P-Value” of each such table, is set forth in infra Appendix, Data Set 3. Itis generally accepted that a P-Value that is below .05, which means there is nomore than a 5% chance that a particular outcome could happen by chance, revealsstatistical significance. With this data set, which compares each state’s delinquencyrate rank to the level of inequality within each state, reveals a P-Value of .011. Id.One of the reasons for requiring such a low P-Value is to make up for samplingerror, which is not an issue with this data set, because no sampling was done: theuniverse of state-by-state data was used, which might suggest that one could be



This graph shows the rank of states in terms of their rankingon the GINI index, lowest income inequality to highest, togetherwith their rank in terms of their delinquency rates (combiningproperties in foreclosure with properties where the borrower ismore than ninety days past due on his or her mortgage) as of De-cember 2009. This graph shows that there is a statistically significantcorrelation between income inequality and delinquency rates.

Using 2006 data on income inequality and 2009 foreclosuredata actually makes some sense. Many of the problems in the mort-gage market stem from activities in 2005 and 2006, when underwrit-ing standards were loosened to maintain mortgage volume to feedthe securitization market.103 Furthermore, subprime adjustable ratemortgages written in 2006 often had two- or three-year teaser ratesso that the monthly payments on mortgages written in those yearslikely did not increase dramatically until 2008 or 2009, when theforeclosure crisis started to hit the hardest.104

Admittedly, many other forces might also be driving this corre-lation between income inequality and delinquency rates. It wouldbe easy to posit that the higher the number of people living in pov-erty, the higher the delinquency rate is likely to be. But the facts donot support this theory.

Table 7 suggests that the poverty rate in a given state may havelittle influence on delinquency rates. A higher poverty rate appearsto have little correlation with delinquency rates.105

more comfortable with the statistical significance of a data set with a higher P-Value in this setting. On the importance of P-Value and its value in settings wheresampling is used, see Michael D. Green, Expert Witnesses and Sufficiency of Evidence inToxic Substances Litigation: The Legacy of Agent Orange and Bendectin Litigation, 86NW. U. L. REV. 643, 682–86 (1992).

103. See OFFICE OF THE COMPTROLLER OF THE CURRENCY, SURVEY OF CREDIT

UNDERWRITING PRACTICES 4 (2006), available at http://www.occ.gov/publications/publications-by-type/survey-credit-underwriting/pub-survey-cred-under-2006.pdf.

104. See A Second Mortgage Disaster on the Horizon?, CBS NEWS (Dec. 14, 2008),http://www.cbsnews.com/stories/2008/12/12/60minutes/main4666112.shtml.At the end of 2008, the “loans made back in the heyday [started] to reset, causingthe mortgage payments to go up and homeowners to default.” Id.

105. Indeed, the P-Value for this graph is quite high (.8), revealing no mean-ingful statistical significance. See infra Appendix, Data Set 3. Since the poverty ratedata and the median income data revealed in this and the next table tend to createa “spread” between the highest and lowest states that can be graphically displayedin a way that is similar to a ranking, no ranking was used in this table or the follow-ing one, which displays median income within each state.



Table 7: Poverty Rate106

Digging deeper into the delinquency data, however, reveals aninteresting phenomenon about the impact of the foreclosure crisis;the higher the median income in a state, the higher the delin-quency rate in that state, as reflected in Table 8.

106. For the data on poverty rates by state, see WEBSTER JR. & BISHAW, supranote 57, at 21 tbl.9. For the delinquency data used, see MBA DATA, supra note 47,at 4.



Table 8: Median Income by State107

It would be easy to say that it is income inequality that is driv-ing this correlation, but median income in a state does not dictateincome inequality. There are states with high income inequality butlow median income, like Louisiana, and states where the opposite istrue, like New Hampshire, where residents enjoy a high median in-come while the state as a whole ranks low on the income inequalityscale.108

Interestingly, when we look at delinquency rates compared tomedian income by race, we actually see that for Whites, AfricanAmericans, and to a lesser extent, Latinos, the higher the medianincome by state for each racial classification, the higher the delin-quency rate.

107. For the data on the median household income by state, see WEBSTER JR.& BISHAW, supra note 57, at 4 tbl.2 & 5 fig.1. The data on delinquency rate ranks bystate can be found at MBA DATA, supra note 47, at 4. Admittedly, this datagenerates a P-Value of .056, placing it just above the level generally recognized asindicating statistical significance. As Table Nine indicates, when this is data isseparated by race, we see new P-Values generated for each racial group measured.These values reveal a correlation between African American median income withina state and the delinquency rate in that state.

108. Louisiana’s median income is $23,986, while its inequality rate is 0.475,ranking it forty-eighth (third highest) in the U.S. In contrast, New Hampshire’smedian income is $43,933, while its inequality rate is 0.417, ranking it third lowestin the United States.



Table 9: Median Income by Race109

109. For the data on the median household income by race, see AmericanFactfinder, U.S. CENSUS BUREAU (2007), http://factfinder.census.gov/ (select “DataSets”; then “American Community Survey”; then “2006 American CommunitySurvey”; then “Selected Population Profiles”; then apply the geographic filters).



These graphs raise the question: how might we explain this dif-ference in delinquency rates in relation to levels of inequality bystate? As stated earlier, a feature of societies with greater economicinequality is that they have lower levels of trust: that is, members ofthe community are less willing to trust other members of that com-munity.110 Research also suggests that lower levels of trust corre-spond with lower levels of trustworthiness, as discussed furtherbelow.111

Looking at how states with high trust fare in terms of delin-quencies, states with higher levels of trust have lower delinquencyrates. Table 10 reveals the possible negative correlation betweentrust and delinquencies.

Table 10: Trust and Delinquencies112

For the data on delinquency rate ranks, see MBA DATA, supra note 47, at 4. Asstated above, see supra note 107, once median income is separated by race, therelationship between median income of the African American population in astate and the delinquency rate in that state seems to indicate a positive, andstatistically significant, correlation. See infra Appendix, Data Set 3.

110. See USLANER, supra note 100, at 187 fig.6-6.111. See infra text accompanying notes 113–22.112. For the trust data, see data from ROBERT D. PUTNAM, BOWLING ALONE:

THE COLLAPSE AND REVIVAL OF AMERICAN COMMUNITY (2000) [hereinafter BOWLING



What, then, does generalized trust itself have to do with preda-tory conduct? Arguably, this measure of trust also identifies thelevel of trustworthiness in a community. That is, when an individualresponds to a question that asks whether he or she trusts others,what the respondent may actually be saying is whether that individ-ual considers him or herself trustworthy. Numerous studies lendcredence to this supposition.

In one such study, researchers assessed the cooperative tenden-cies of undergraduates who were paired together as “senders” and“receivers.”113 Senders were given a sum of money and invited toshare this sum with a receiver; whatever sum the sender sent wasmatched by the researchers, and receivers were encouraged toshare what they received with the senders by returning a portion ofwhat they received.114 The optimal outcome for both participantsinvolved the sender sharing his or her entire grant with the re-ceiver, and the receiver splitting what he or she received evenly andsending one of the divided portions back to the sender.

Prior to conducting the study, the researchers measured thelevel of trust among the study’s participants. The answers revealedthat the level of trust among senders bore little relation to theamount they shared with their partners.115 Instead, the extent andlevel of cooperation by the receiver was directly related to his or herlevel of trust, leading the researchers to conclude that “the stan-dard trust questions may be picking up trustworthiness rather thantrust.”116 They also implied from these findings that, in order tofind out if someone is trustworthy, one should ask the personwhether he or she trusts others.117

Lest we think these findings are relevant in ivory tower settingsonly, a similar study of residents of rural Bangladesh reached simi-

ALONE DATA], available at http://www.bowlingalone.com/data.htm. For thedelinquency data used, see MBA DATA, supra note 47, at 4. States excluded aboveare states for which the GSS Data is not available. Admittedly, the P-Value for thisgraph shows a roughly one in fourteen chance that this data could appearrandomly (i.e., a P-Value of .07), which is considered in the range of P-Values thatare “marginally statistically significant,” that is, having a P-Value between .1 and.05. On marginal statistical significance, see Kimberly West-Faulcon, The River RunsDry: When Title VI Trumps State Anti-Affirmative Action Laws, 157 U. PA. L. REV. 1075,1136 n.211 (2009).

113. See Glaeser et al., supra note 12, at 812. For an earlier version of this typeof study, see Joyce Berg et al., Trust, Reciprocity, and Social History, 10 GAMES &ECON. BEHAV. 122 (1995).

114. Glaeser et al., supra note 12, at 812.115. Id. at 826.116. Id. at 833.117. Id.



lar outcomes, leading the researchers there to conclude that “statedtrust is a better predictor of the amount sent back by the receivers,than of the amount sent by the senders in the trust game.”118 Simi-larly, analyzing cross-country “lost wallet experiments,” researchconcluded that residents of countries with high levels of genera-lized trust were more likely to return lost wallets than residents ofnations with lower levels of generalized trust.119 These findingsshow that people are more trustworthy—i.e., they return lost walletswith greater frequency—in countries where trust is high. Thus,trustworthy conduct can be found in nations with high levels oftrust. In other words, when one finds high levels of trust some-where, one is also going to find high levels of trustworthiness.120

Going further, one indicator of trustworthiness—the level of crimein a community—corresponds to levels of trust in a particular com-munity, as Table 11 implies. Lower levels of trust correspond to ahigher crime rate.

118. Olof Johansson-Stenman et al., Trust, Trust Games and Stated Trust: Evi-dence from Rural Bangladesh 22 (Goteborg Univ. Dep’t of Econ., Working Paper No.166, 2005), available at http://gupea.ub.gu.se/bitstream/2077/2758/1/gunwpe0166.pdf.

119. Stephen Knack, Trust, Associational Life and Economic Performance18–22 (Mar. 19, 2000) (prepared for the HRDC-OECD International Symposiumon the Contribution of Investment in Human and Social Capital to Sustained Eco-nomic Growth and Well-Being), available at http://www.oecd.org/dataoecd/6/31/1825662.pdf (analyzing Readers Digest study involving lost wallets in severalnations and U.S. cities, and showing that rate of return of such wallets corre-sponded to levels of generalized trust in those areas).

120. There is an obvious feedback loop between trust and trustworthiness;one is more likely to be trusting the more one observes trustworthy behavior. Con-versely, the more one is the victim of predatory conduct, the less likely he or she isto trust others. This phenomenon poses particular challenges in the wake of thefinancial crisis in terms of rebuilding trust in financial institutions. Those burnedby such institutions are less likely to be trusting of those institutions, and otherslike them, in the future. In a fascinating study of the effects of the Bernie Madoffscandal on trust in financial institutions, researchers found a drop in trust in suchinstitutions in communities hardest hit by Madoff’s Ponzi scheme. Luigi Guiso, ATrust-Driven Financial Crisis: Implications for the Future of Financial Markets 8–10 (Eur.Univ. Inst., Working Paper No. 2010/07, 2009), available at http://Cadmus.eui.eu/bitstream/handle/1814/13657/ECO_2010_07.pdf?sequence=3.



Table 11: Trust and Crime Rate Rank121

If indicators of trust are also (or perhaps actually) indicators oftrustworthiness, then it makes sense that states with lower levels oftrust have a greater prevalence of delinquencies—that is, stateswhere people are less trustworthy are also states in which uncooper-ative and predatory conduct is more likely to take place. As Table12 reveals, taking general crime rates, set forth in the previous ta-ble, and comparing them to delinquency rates, there is a similarcorrelation between the two data sets. This makes sense since, asshown before, lower levels of trust correspond to higher delin-quency rates.

121. The P-Value for this graph is particularly strong. See infra Appendix, DataSet 3. For the GSS data on trustworthiness, see BOWLING ALONE DATA, supra note112. For crime rate data, see U.S. DEP’T OF JUSTICE, 2008 CRIME IN THE UNITED

STATES, tbl.5 (2008), available at http://www2.fbi.gov/ucr/cius2008/data/table_05.html.



Table 12: Delinquency Rate Rank and Crime Rate Rank122

This potential correlation between crime rates, levels of trustand trustworthiness, and delinquencies suggests that the presenceof low trust/trustworthiness, which brings with it higher crimerates, may be correlated with high delinquencies and a greater like-lihood of predatory conduct. This correlation implies the possibilitythat such predatory conduct may have been one of the drivingforces behind such delinquencies. States with higher crime rates, bydefinition, are states in which predatory conduct is more prevalent.It is not a stretch to suggest then that such states were also stateswhere predatory lending was likely to flourish. Since there is a possi-ble correlation between trust, trustworthiness, crime rates, and de-linquencies, it is also not a stretch to presume that such predatoryconduct is likely to have helped to fuel some of the behavior be-hind the delinquencies that are at the root cause of the foreclosurecrisis.

122. For the P-Value of this Table, see infra Appendix, Data Set 3. As withTable Ten, supra, the P-Value for this table is within the range of “marginalstatistical significance.” For delinquency rate ranks, see MBA DATA, supra note 47,at 4. For crime rate data, see U.S. DEP’T OF JUSTICE, supra note 121.



Another way that social scientists determine the level of trustwithin a given community is to look at the relative level of “socialcapital” within that community.123 As Robert Putnam, the author ofthe landmark work “Bowling Alone,” describes it, social capital ismanifest in the “social networks and the . . . norms of reciprocityand trustworthiness” associated with such networks.124

These networks and norms facilitate cooperative behavior bygenerating feelings of mutual obligation towards other members ofa network.125 Communities that have high levels of social capital arebetter off economically and have lower crime rates; the residents ofthose communities report higher levels of life satisfaction.126 Levelsof social capital also tend to correspond with levels of trustworthi-ness because of the symbiotic relationship between trust, trustwor-thiness and social capital.127

Returning to the foreclosure crisis, according to commentatorsfrom different points on the political spectrum—from Nobel Prize-winning economist Joseph Stiglitz128 and Nobel Peace Prize recipi-ent Muhammad Yunus,129 to Federal Deposit Insurance Corpora-

123. The level of social capital within a community is sometimes considered a“proxy” for the level of trust in that community, and vice versa. See, e.g., FrancisFukuyama, Social Capital and Civil Society 4–5 (Int’l Monetary Fund, Working PaperNo. 00/74, 2000), available at http://www.imf.org/external/pubs/ft/wp/2000/wp0074.pdf (describing interplay between trust and social capital); PIPPA NORRIS,DEMOCRATIC PHOENIX 166 (2002) (describing the same); Luigi Guiso et al., TheRole of Social Capital in Financial Development, 94 AM. ECON. REV. 526, 528 (2004)(characterizing “high-social-capital areas as those with high levels of generalizedtrust”).

124. Robert D. Putnam, E Pluribus Unum: Diversity and Community in theTwenty-first Century, 30 SCANDINAVIAN POL. STUD. 137, 137 (2007).

125. On the ways in which social capital develops trust among the members ofa network, see James S. Coleman, Social Capital in the Creation of Human Capital, 94AM. J. SOC. S95, S119 (Supp. 1988).

126. For an overview of the benefits of social capital, see Michael Woolcock,The Place of Social Capital in Understanding Social and Economic Outcomes, 2 ISUMA:CAN. J. POL’Y RES. 1 (2001).

127. See Robert D. Putnam, Bowling Alone: America’s Declining Social Capital, 6 J.DEMOCRACY 65 (1995), reprinted in CULTURAL METAPHORS: READINGS, RESEARCH

TRANSLATIONS, AND COMMENTARY 109, 111 (Martin J. Gannon ed., 2001).128. JOSEPH E. STIGLITZ, FREEFALL: AMERICA, FREE MARKETS, AND THE SINKING

OF THE WORLD ECONOMY 14 (2010).129. When asked why Grameen Bank is expanding and its microlending port-

folio has a 99% success rate when, in the wake of the financial crisis, other finan-cial institutions are pulling back on credit, Yunus attributed this to the relationshipbetween the bank and its customers:

One thing I would say [sic] that very close relationship between the lenderand the borrower. That relationship disappeared in a conventional bank. Youlend the money to borrower, you know her or you came to know here [sic].



tion (FDIC) Chair Sheila Bair130—one of the root causes of thefinancial crisis was the breakdown of the traditional borrower-lender relationship. In the traditional relationship, the lender wasconcerned with the long-term viability of the borrower becausebank income and profitability hinged on the dependability of theborrower over the long run.131 These long-term bonds and commit-ments were likely infused with aspects of social capital.132 Withsecuritization came the breakdown of the traditional bor-rower–lender relationship, as lenders were looking to “originate tosecuritize,” keeping loans on their books for days, or even hours,just until they could sell them to investment banks to be packagedand sold off as securities.133 Stiglitz describes this transformation asfollows:

Securitization, the hottest financial-products field in the yearsleading up to the collapse, provided a textbook example of the

And you give the loan. And then you sell the document to somebody else. Theperson who is now owning it doesn’t know this person anymore. And this hasbeen sold, and sold, many times, with nothing to do with the person who stillowes the money.

So, the relationship has disappeared completely. So we have to go back tothe original concept of banking. They stole that relationship. I think that is avery important element that we have to com [sic] back to.

Quest Means Business (CNN television broadcast May 19, 2010) (transcript availableat http://transcripts.cnn.com/TRANSCRIPTS/1005/19/qmb.01.html) (interviewby Maggie Lake with Muhammad Yunus, Founder, Grameen Bank, in New York,NY).

130. Sheila C. Bair, Chairman, Fed. Deposit Ins. Corp., Possible Responses toRising Mortgage Foreclosures Before the Committee on Financial Services, U.S.House of Representatives (Apr. 17, 2007) [hereinafter Blair Testimony], availableat http://www.fdic.gov/news/news/speeches/archives/2007/chairman/spapr1707.html.

131. Frank A. Hirsch, Jr., The Evolution of a Suitability Standard in the MortgageLending Industry: The Subprime Meltdown Fuels the Fires of Change, BNET (Mar. 2008),http://findarticles.com/p/articles/mi_6779/is_12/ai_n28511999/ (asserting that“most lenders, prior to the recent increase in subprime mortgages, were unwillingto make a loan in which they doubted the borrower’s ability to repay”).

132. Of course, these bonds could easily have their down side, and bankerscould play favorites, give in to stereotypes, and discriminate with impunity. At thesame time, such character assessment could come with close and frequent contactwith one’s banker. In Frank Capra’s classic film, the community banker’s bedtimestory, “It’s a Wonderful Life,” Lionel Barrymore’s Potter, the model of a corrupt,profit-driven banker, criticizes what he sees as the Bailey Building & Loan’s favorit-ism in its underwriting approach: “You see, if you shoot pool with some employeehere, you can come and borrow money.” IT’S A WONDERFUL LIFE (Liberty Films1946).

133. On the “originate to securitize” or “originate to distribute” model, seeKiff & Mills, supra note 24, at 11–16.



risks generated by the new innovations, for it meant that therelationship between lender and borrower was broken . . . . Inthe Frankenstein laboratories of Wall Street, banks created newrisk products (collateralized debt instruments, collateralizeddebt instruments squared, and credit default swaps . . . ) with-out mechanisms to manage the monster they had created.They had gone into the moving business—taking mortgagesfrom the mortgage originator, repackaging them, and movingthem onto the books of pension funds and others—becausethat was where the fees were the highest, as opposed to the“storage business,” which had been the traditional businessmodel for banks (originating mortgages and then holding onto them).134

While the initial assessment of creditworthiness was likelycolored by the depth of the relationship between the prospectiveborrower and his or her bank, once the deal was consummated, atemporary economic setback would be forgiven more easily whenthe borrower could communicate with his or her banker and seekforbearance directly, as opposed to dealing with a servicer callcenter in another state or country.135

134. STIGLITZ, supra note 128, at 14.135. Caroline Baum, Paulson Goes to Washington, Loses Way, BLOOMBERG (Dec.

4, 2007), http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aFLLy4LlxCmc. As Sheila Bair has explained: “[T]he increased complexity of the structureand the different interests of the various securitization parties can make creditworkout strategies more complicated than in a direct borrower/lender relation-ship.” Bair, supra note 130. Stiglitz describes the transformation of mortgage rene-gotiation dynamics as follows:

Banks with long-standing relations with the community had an incentive totreat borrowers who got into trouble well; if there was a good chance thatborrowers would catch up on their payments if they were given some time,then the bank would give them the time they needed. But the distant holdersof the mortgages had no interest in the community and no concern abouthaving a reputation as a good lender.

STIGLITZ, supra note 128, at 95.



If there is a connection between social capital and delinquencyrates, the level of social capital in a community will also impact de-linquency rates. Comparing a state’s relative social capital rank, us-ing Putnam’s social capital index,136 with delinquency rate rank bystate, reveals a correlation between high levels of social capital andlow delinquency rates, at least with respect to states that are notexperiencing above-average unemployment rates, as Table 13indicates.

136. Putnam’s social capital index includes fourteen indicators, includingthose that measure the level of participation in civic organizations, the level oftrust in a community, and the number of non-profit organizations per 1000 re-sidents in a community. See BOWLING ALONE DATA, supra note 112. Admittedly, thissocial capital index was generated when Bowling Alone was published, and has notbeen updated. Using this data is helpful, though, to show that social capital washigh or low in a particular state prior to the changes in the economy, most notably,the rise in home values, which marked the middle part of the last decade.



Table 13: Social Capital and Unemployment Data137

137. For the social capital data, see BOWLING ALONE DATA, supra note 112. Forthe delinquency data used, see MBA DATA, supra note 47, at 4. For unemploymentdata, see U.S. Dep’t of Labor: Bureau of Labor Statistics, Unemployment Rates forStates, LOCAL AREA UNEMPLOYMENT STATISTICS, http://www.bls.gov/lau/lastrk09.



For the most part, the higher the social capital, the lower thedelinquency rate. Here, the data is separated for states with similarunemployment rates. In states with average or below-average unem-ployment rates, we see a strong negative correlation between socialcapital and foreclosure rates. In states with above-average unem-ployment rates, there is a slight positive correlation. This may eitherbe a statistical anomaly, or social capital may have no positive effectson foreclosure rates in the face of extreme economic distress, likehaving double-digit unemployment within a state.

The findings with respect to a generally negative correlationbetween foreclosure rates and social capital correspond to similarfindings reached by the Corporation for National and CommunityService (CNCS) in its study of foreclosure rates and volunteering(another reflection of social capital) in large U.S. cities in 2008 and2009. “Looking at the relationship between foreclosure and volun-teer rates, [CNCS] found that cities with higher foreclosure ratestended to have lower volunteer rates. [The] findings show that aone percent decrease in foreclosure rates would be associated witha 1.2 percent increase in volunteer rate.”138

If these correlations are present, then it is worth discussingwhether the absence of social capital may have been one of the driv-ing forces behind the foreclosure crisis.

C. Racial Distance and the Foreclosure Crisis

Another type of social distance can come about as a result ofdistinctions based on race. Again, according to the theory, racialdifferences can lead to the same sort of predatory conduct that oc-curs where there is greater income inequality.139 For this to holdtrue in the financial crisis, we would have to see an increase in theoccurrence of predatory conduct in communities of color.

Looking at lending during the heart of the subprime mortgagefrenzy in 2006, the Federal Reserve’s analysis of Home MortgageDisclosure Act (HMDA) data reveals that nearly 54% of the home

htm (last modified Mar. 8, 2010). For the P-Values for this chart, see infraAppendix, Data Set 3. As stated above, there is no statistically significant impact ofsocial capital on delinquencies in states with high unemployment.

138. CORP. FOR NAT’L & CMTY. SERV., ISSUE BRIEF, VOLUNTEERING IN AMERICA

2010: NATIONAL, STATE AND CITY INFORMATION 8–9 (2010), available at http://www.volunteeringinamerica.gov/assets/resources/IssueBriefFINALJune15.pdf.

139. See supra text accompanying notes 94–98. For an overview of research onsocial distance and race relations, see Ralph Richard Banks & Richard ThompsonFord, (How) Does Unconscious Bias Matter?: Law, Politics, and Racial Inequality, 58EMORY L.J. 1053, 1069–72 (2009), and sources cited therein.



purchase loans made to African Americans in that year had sub-prime features, compared to just under 18% for Whites, a nearlythree-to-one ratio.140

Controlling for borrower characteristics,141 the Fed found thatin 2006, over 30% of African American borrowers and 24% of La-tino borrowers, compared to just under 18% of White borrowers ofcomparable creditworthiness, received subprime loan products.142

Thus, an African American borrower of similar creditworthiness toa White borrowers was 75% more likely to receive a subprime loanproduct than the White borrower, and a Latino borrower was 36%more likely to take out a subprime loan than a White borrower witha similar economic profile.

A study done by the New York Times on lending in the NewYork City metropolitan region found the prevalence of lending pat-terns even more striking, particularly as it related to working-class

140. See Robert B. Avery et al., The 2006 HMDA Data, 93 FED. RES. BULL. A73,A95 (2007) [hereinafter 2006 HMDA Data], available at http://www.federalreserve.gov/pubs/bulletin/2007/pdf/hmda06final.pdf.

141. The authors controlled for borrower characteristics by utilizing a“matching procedure” in assessing the 2004 and 2005 HMDA data. Id. This proce-dure allowed the Fed to measure “differences in denial rates by comparing applica-tions for a specific loan product filed by applicants who differ by race, ethnicity, orsex but who are matched on the basis of the limited set of items in the HMDAdata.” Robert B. Avery et al., New Information Reported under HMDA and Its Applica-tion in Fair Lending Enforcement, 91 FED. RES. BULL. 344, 387 (2005) (emphasis omit-ted), available at http://www.federalreserve.gov/pubs/bulletin/2005/3-05hmda.pdf. The HMDA data can be manipulated, allowing

individuals to be matched by loan type and purpose, type of property securingthe loan, lien status, owner-occupancy status, property location (for example,same MSA or even same census tract), income relied on for underwriting,loan amount, and time of year when the loan was made as well as by whetherthe loan involved a co-applicant.

Id. at 372. In 2006, a control for lender was also added. 2006 HMDA Data, supranote 140, at A95.

142. Id. at A96 tbl.11. A subprime loan is a loan made to a borrower whopossesses certain features:

Subprime borrowers typically have weakened credit histories that include pay-ment delinquencies, and possibly more severe problems such as charge-offs,judgments, and bankruptcies. They may also display reduced repayment ca-pacity as measured by credit scores, debt-to-income ratios, or other criteriathat may encompass borrowers with incomplete credit histories. Subprimeloans are loans to borrowers displaying one or more of these characteristics atthe time of origination or purchase.

OFFICE OF THE COMPTROLLER OF THE CURRENCY ET AL., EXPANDED GUIDANCE FOR

SUBPRIME LENDING PROGRAMS 2 (2001), available at http://www.federalreserve.gov/boarddocs/press/boardacts/2001/20010131/attachment.pdf.



African Americans.143 Indeed, after studying lending patterns inthe city and comparing borrowers of similar incomes, the research-ers concluded as follows: “[T]he hardest blows rain down on thebackbone of minority neighborhoods: the black middle class. InNew York City, for example, black households making more than$68,000 a year are almost five times as likely to hold high-interestsubprime mortgages as are whites of similar — or even lower —incomes.”144

Deeper analysis of HMDA data reveals that 169 mortgage lend-ers failed in 2007, following the collapse of the housing market.145

With these lenders, who were most likely engaged in the riskiestlending (hence their closing their doors in 2007), a disproportion-ate share of their subprime lending in 2006 was directed towardsAfrican American borrowers when compared to lending in the in-dustry as a whole. Indeed, 74% of the loans made by these lendersto African Americans in 2006 were subprime loans, and 63% of theloans to Latinos were subprime, compared to an industry average of54% and 47% respectively, as Table 14 indicates.146 Thus, it appearsthat the riskiest subprime lending in 2006 was carried out by lend-ers that focused such lending on borrowers of color.

143. Michael Powell & Janet Roberts, Minorities Hit Hardest as New York Foreclo-sures Rise, N.Y. TIMES, May 16, 2009, at A1.

144. Id.145. Robert B. Avery et al., The 2007 HMDA Data, 94 FED. RES. BULL. A107,

A109 (2008), available at http://www.federalreserve.gov/pubs/bulletin/2008/pdf/hmda07final.pdf.

146. For the failed institutions data, see id. at A126 tbl.12. For the industryaverage data see 2006 HMDA Data, supra note 140, at A95–96.



Table 14: Data on 2007 Failed Institutions147

What does all of this information say about economic and ra-cial inequality and the financial crisis? States with greater inequalityare also states in which predatory conduct is likely to be more prev-alent. Is it possible then, that in states with greater inequality, theirhigher delinquency rates may be a function of the fact that preda-tory conduct, in the form of predatory lending, was more preva-lent? Similarly, mortgage lenders concentrated a disproportionateshare of their subprime lending in African American and Latinocommunities. A fair number of these borrowers saddled with sub-prime loans would have qualified for prime loans, which they wouldhave stood a better chance of paying back, sparing themselves theordeal of foreclosure.148 The lenders that pedaled toxic products in

147. The data on failed institutions by race was obtained from Avery et al.,supra note 145, at A126 tbl.12. The data on the 2006 industry average was obtainedfrom the 2006 HMDA Data, supra note 140, at A95–96.

148. Estimates place the number of subprime borrowers who would havequalified for prime loans between 35% and 61%. See The Community ReinvestmentAct: Thirty Years of Accomplishments but Challenges Remain, Hearing Before the H. Comm.on Fin. Servs., 110th Cong. 4 (2008) (prepared testimony of Michael S. Barr, Profes-sor, Univ. of Mich. Law Sch.), available at http://financialservices.house.gov/hear-ing110/barr021308.pdf (arguing that 35% of subprime borrowers would havequalified for prime loans); Rick Brooks & Ruth Simon, Subprime Debacle Traps EvenVery Credit-Worthy: As Housing Boomed, Industry Pushed Loans to a Broader Market,



those communities are the ones who should be held largely respon-sible for what ensued, not their victims.

Indeed, as a growing body of evidence strongly suggests, theproblem in the mortgage market was not risky borrowers but preda-tory loans. One study by the Center for Community Capital at theUniversity of North Carolina compared the performance of riskysubprime loans with loans where strong underwriting guidelineswere used.149 The Center identified borrowers of similar profilesthat entered into either the risky loans or the more stable loans.150

That study found that for loans made in 2004, the subprime loanswere four times more likely to enter into default than the morestable loan products; in 2006, they were 3.3 times as likely.151 Imag-ine the amount of suffering that could be alleviated if foreclosurerates were reduced by 67% or even 75%.

A critical aspect of the theory about social distance is thatgreater social distance leads to non-cooperative, predatory conduct.Is it possible, then, that the problem was borrower fraud and notjust predatory lending? Were borrowers behaving in an untrustwor-thy fashion? Certainly some were, but according to FBI estimatesroughly 80% of losses due to mortgage fraud involved lender and/or broker misconduct.152 Indeed, an internal study from 2005 con-ducted by Washington Mutual of just one of its offices, inMontebello, California, revealed that 83% of the mortgages gener-ated by that office involved some form of fraud on the part of bankofficials.153

WALL ST. J., Dec. 3, 2007, at A1 (reporting that 61% of subprime loans originatedin 2006 “went to people with credit scores high enough to often qualify for conven-tional[, i.e., prime,] loans with far better terms”). In his recent book, Gary Rivlinputs it succinctly: “The problem wasn’t the people [receiving the loans] but theproduct they were being sold.” GARY RIVLIN, BROKE USA: FROM PAWNSHOPS TO POV-

ERTY INC.—HOW THE WORKING POOR BECAME BIG BUSINESS 133 (2010).149. Lei Ding et al., Risky Borrowers or Risky Mortgages: Disaggregating Effects Us-

ing Propensity Score Models 1 (Univ. of N.C. Ctr. for Cmty. Capital, 2010), available athttp://www.ccc.unc.edu/documents/Risky.Disaggreg.5.17.10.pdf.

150. Id. at 15–16.151. Id. at 28.152. U.S. DEP’T OF JUSTICE: FED. BUREAU OF INVESTIGATIONS, FINANCIAL CRIMES

REPORT TO THE PUBLIC D1–D12 (2005), available at http://www.fbi.gov/stats-services/publications/fcs_report2005/financial-crimes-report - to - the -public -2005-pdf.

153. On April 13, 2010, the Permanent Subcommittee on Investigations,headed by Senator Carl Levin, began holding hearings aimed at examining “someof the causes and consequences of the recent financial crisis.” Memorandum fromSenator Carl Levin, Subcomm. Chairman, to Members of the Permanent Sub-comm. on Investigations 1 (Apr. 13, 2010) [hereinafter Levin Memo], available at



In one recently filed lawsuit under the Fair Housing Act, for-mer employees of the defendant Wells Fargo, an aggressive sub-prime lender,154 alleged the following:

Wells Fargo’s Memphis branches targeted African Americansfor subprime loans because employees held negative views ofAfrican Americans. [Former bank employee] Taylor explainsthat “[t]he prevailing attitude was that African American cus-tomers weren’t savvy enough to know they were getting a badloan, so we would have a better chance of convincing them toapply for a high-cost, subprime loan.”

http://levin.senate.gov/newsroom/supporting/2010/PSI.LevinCoburnmemo.041310.pdf.

In particular, the subcommittee focused on a case study involving WashingtonMutual Bank (WaMu). The hearings revealed that, in 2005, WaMu itself had con-ducted an internal investigation that turned up a number of red flags regarding itslending practices. David Heath, WaMu Executives Knew of Rampant Mortgage Fraudand Failed to Act, HUFFINGTON POST (Apr. 12, 2010), http://www.huffingtonpost.com/2010/04/12/wamu-executives-knew-of-r_n_534800.html. The investigationuncovered that:

[L]oans originated from two top loan offices in southern California containedan extensive level of fraud . . . . Despite fraud rates in excess of 58% and 83%at those two offices, no steps were taken to address the problems, and noinvestors who purchased loans originated by those offices were notified . . . ofthe fraud problem.

Levin Memo, supra, at 4. James Vanasek was one of the former WaMu executiveswho testified before the subcommittee. Despite assertions of other executives thatthey had not been aware of the impending housing crisis early on, Vanasek “saidhe realized in 2004 that ‘the industry was in some degree of difficulty . . . .’” KirstenGrind, WaMu Hearing Begins, PUGET SOUND BUS. J. (Apr. 13, 2010), http://seat-tle.bizjournals.com/seattle/blog/2010/04/wamu_hearing_begins.html.

Another 2007 internal investigation of one of the southern California WaMuoffices uncovered a fraud rate of 62%. Levin Memo, supra, at 4. WaMu, along withits affiliate, Long Beach Mortgage Company, compounded this problem by “creat-ing misplaced incentives that encouraged high volumes of risky loans but little orno incentives to ensure high quality loans that complied with the bank’s creditrequirements.” Id. at 2, 4–5. In addition to the 2005 and 2007 internal investiga-tions, a number of other documents were uncovered which included discussionsamong the Board of Directors as well as various emails, all of which clearly illus-trated the higher risk lending strategies that were rampant throughout the com-pany from 2003 to 2008. Wall Street and the Financial Crisis: The Role of High RiskHome Loans, Hearing Before the S. Permanent Subcomm. on Investigations, 111th Cong.at 2–9 (Apr. 13, 2010) (exhibit list), available at http://hsgac.senate.gov/public/_files/Financial_Crisis/041310Exhibits.pdf. One internal report did conclude that“[t]hroughout the process, red flags were over-looked, process requirements werewaived, and exceptions to policy were granted.” Heath, supra (internal quotationsomitted).

154. Michael Powell, Suit Accuses Wells Fargo of Steering Blacks to Subprime Mort-gages in Baltimore, N.Y. TIMES, June 7, 2009, at A16.



Likewise, Thomas[, another former bank employee,] explainsthat “[i]t was generally assumed that African American custom-ers were less sophisticated and intelligent and could bemanipulated more easily into a subprime loan with expensiveterms than white customers.”155

Assuming these allegations are true, it appears likely thatgreater social distance, both in terms of economic and racial ine-quality, created the conditions in which predatory conductflourished.

Finally, putting together a number of gauges of social distancecaused by economic and racial inequality, Table 16 combines anumber of factors outlined above that likely played out in harmfulways in the financial crisis: greater economic inequality, median in-come of the African American community in a state, and percent-age of the African American community in a particular state.Putting these indicators together generates a graph that supportsthe theory that the African American middle class was targeted forsubprime loans.

155. First Amended Complaint for Declaratory and Injunctive Relief andDamages at 32–33, City of Memphis v. Wells Fargo Bank (W.D. Tenn. Apr. 7, 2010)(No. 2:09-cv-02857x), 2010 WL 1506670. Similarly, a CitiFinancial branch managerdescribed that lender’s approach as follows: “‘[t]he more gullible the consumerappeared . . . the more [additional costs] . . . I would try to include in the loan.’ By‘gullible,’ she explained, she meant the very young or the very old, minorities andthose who ‘appeared uneducated, inarticulate.’” Rivlin, supra note 148, at 152.



Table 15: Targeting the Black Middle Class156

This data analysis is consistent with the findings of a joint re-port by the U.S. Department of Housing and Urban Development(HUD) and U.S. Department of the Treasury issued in 2000 onpredatory lending157 and later studies conducted during the sub-prime mortgage market’s heyday.158 In the HUD–Treasury report,these agencies found that predatory lending was more prevalent inthe subprime market than the prime market and that such sub-

156. This Table has the strongest P-Value of the tables generated for thisstudy. See infra Appendix, Data Set 3. For the data on black middle class income,see US CENSUS BUREAU, supra note 109. The data on delinquency rate ranks bystate can be found at MBA DATA, supra note 47, at 4. The P-Value for this graph asa whole, as well as for each of the separate data sets used and their relation to thedelinquency rates with respect to each data set is set forth in the Appendix, DataSet 3, infra. In creating this index, these indicators were given equal weight. Onthe selection and weighting of criteria in the creation of an index, see Roodman,supra note 17, at 5–7.

157. U.S. DEP’T OF HOUS. & URBAN DEV. & U.S. DEP’T OF TREASURY, CURBING

PREDATORY HOME MORTGAGE LENDING 47–48 (2000) [hereinafter HUD-TREASURY

REPORT], available at http://www.huduser.org/Publications/pdf/treasrpt.pdf.158. See infra note 163 and accompanying text.



prime lending was prevalent in communities of color.159 Such com-munities, HUD and Treasury found, tended to be underserved bywhat the agencies called “traditional prime lenders,” which theyidentified as banks, thrifts, and credit unions, all of which are sub-ject to more federal oversight than mortgage finance companies.160

In a later report, the National Community Reinvestment Coalitiondescribed the effects of a legacy of discrimination in communitiesof color as paving the way for subprime lenders to flourish in thosecommunities:

[M]inority borrowers and communities that received dispro-portionately high numbers of subprime loans had historicallylower homeownership rates, as they were systematically ex-cluded from home mortgages due to bank-redlining and dis-crimination until the early 1980s. Then, when financialinstitutions rapidly expanded their lending to minorityhouseholds it was associated with the use of high-cost, orotherwise unfair and abusive products. The resulting high den-sity of subprime loans “increases the risk of foreclosures andnegative spillover effects like declines in property values andincreasing crime rates.” Hence, a larger proportion of home-owners are facing foreclosures in predominantly minorityneighborhoods.161

A legacy of discrimination in certain communities,162 thattranslated into a lower homeownership rate in those communities,meant such areas were fertile ground for the expansion of sub-prime lending that occurred in the last decade. With few primebanking alternatives, middle and lower-middle class borrowers ofcolor were targeted for subprime loans and steered into loans withless favorable terms than they might have otherwise accessed hadthey had better credit alternatives available to them.163 The thin

159. HUD-TREASURY REPORT, supra note 157, at 16, 47–48.160. Id. at 18.161. Tamara Jayasundera et al., Foreclosure in the Nation’s Capital: How Unfair

and Reckless Lending Undermines Homeownership 19 (Nat’l Cmty. Reinvestment Coal.,2010) (citations omitted), available at http://www.ncrc.org/images/stories/pdf/research/ncrc_foreclosure_paper_final.pdf.

162. On the history of housing discrimination in the United States, see DAN

IMMERGLUCK, CREDIT TO THE COMMUNITY: COMMUNITY REINVESTMENT AND FAIR

LENDING POLICY IN THE UNITED STATES 87–108 (2004); Adam Gordon, The Creationof Homeownership: How New Deal Changes in Banking Regulation Simultaneously MadeHomeownership Accessible to Whites and Out of Reach for Blacks, 115 YALE L.J. 186(2005).

163. For an analysis of lending patterns in seven metropolitan areas, whichshowed 40% of the activities of subprime lenders concentrated in communities of



market for mainstream financial institutions in communities ofcolor—the legacy of credit redlining—is precisely what narrowedthe options available to the residents of such communities. The cor-relation between borrower median income and the size of the Afri-can American population with foreclosure rates in a state wouldsuggest that the larger the African American middle class in a com-munity, and the wealthier it was, the more likely that subprimelending was prevalent in that community and the more likely thatthe African American middle class was targeted for loans on lessthan favorable terms.164 These less than favorable terms led to theforeclosure crisis now plaguing those very same communities, withdevastating effects.

III.AN ALTERNATIVE EXPLANATION AND

A RESPONSE

As described above, Rajan and others have argued that govern-ment policies—most notably the demands of the CRA and the af-fordable housing goals of the GSEs—were responsible for thehousing bubble and the financial collapse that followed the burst-ing of that bubble.165 In order for these arguments to hold true,their proponents would have to show that it was CRA oversight thatforced subprime lenders to engage in risky lending, that the GSE

color, while only 10% of their lending taking place in white communities, see CAL.REINVESTMENT COAL. ET AL., PAYING MORE FOR THE AMERICAN DREAM: THE SUBPRIME

SHAKEOUT AND ITS IMPACT ON LOWER-INCOME AND MINORITY COMMUNITIES 5(2008), available at http://www.woodstockinst.org/publications/download/paying-more-for-the-american-dream-%11-the-subprime-shakeout-and-its-impact-on-lower%11income-and-minority-communities.

164. Another potential explanation for the prevalence of foreclosures in com-munities with larger African American populations is the theory that communitieswith greater population heterogeneity have lower social capital. The logical con-clusion to be drawn from such a theory is that this lowered social capital also tendsto correspond with higher foreclosure rates, as we have already seen. If the correla-tion between social capital, trust, and cooperative behavior is well-founded, thenthe potential correlation between population heterogeneity and predatory con-duct is certainly cause for alarm. This controversial issue is addressed in RobertPutnam’s relatively recent work on the subject, Putnam, E Pluribus Unum, supranote 124. For a response to Putnam, see Casey J. Dawkins, Reflections on Diversity andSocial Capital: A Critique of Robert D. Putnam’s “E Pluribus Unum: Diversity and Com-munity in the Twenty-First Century the 2006 Johan Skytte Prize Lecture,” 19 HOUS. POL’YDEBATE 207 (2008). For a description of the ways in which mortgage lenders actu-ally used social capital networks to gain entre into communities of color, see Cre-ola Johnson, The Magic of Group Identity: How Predatory Lenders Use Minorities to TargetCommunities of Color, 17 GEO. J. POVERTY L. & POL’Y 165 (2010).

165. See RAJAN, supra note 83, at 34–37, 43–45.



policies were driving the subprime mortgage market, and that GSEunderwriting standards were weaker than those of lenders acting ontheir own, selling bundled mortgages on the strictly private market.As the following discussion shows, not one of these factual supposi-tions enjoys much support.

A. The CRA: Not Guilty

Given our previous discussion of income inequality and its po-tential connection to financial crises, it is particularly salient to dis-cuss the Community Reinvestment Act (CRA) because it wasoriginally designed to protect the interests of low- and moderate-income communities.166 As a result, it was originally crafted to com-bat income inequality, or at least the distortions that income ine-quality creates on credit markets.167 If the previous informationabout income inequality and the foreclosure crisis suggests that thepublic should be concerned with the impact of such inequality onhousing finance policy, then there is no better place to start than tolook at the CRA to see its impact on causing or failing to preventthe financial crisis. That some have attempted to lay the blame forthe crisis on the CRA only strengthens the need to analyze its pur-pose, scope, successes, and failures.

Under the CRA, federal bank regulators are to use their au-thority “to encourage [financial] institutions to help meet the creditneeds of the local communities in which they are chartered,” solong as this goal can be carried out “consistent with the safe andsound operation of such institutions.”168 The CRA was enacted tocombat two practices that Congress found to undermine the eco-nomic health of low- and moderate-income communities: bank red-lining (excluding certain communities from access to capital) andcapital exportation (taking deposits from a community while refus-ing to lend within that community).169 The policies of the CRAwere also seen as a quid pro quo for the substantial benefits that

166. The original language of the CRA was amended during debates over itspassage to include consideration of low- and moderate-income communities, asopposed to focusing on the needs of banks’ “primary service area”. H.R. REP. NO.95-634, at 75-76 (1977) (Conf. Rep.).

167. On the distortions on credit markets affecting low- and moderate-in-come communities, see Michael S. Barr, Credit Where It Counts: The Community Rein-vestment Act and Its Critics, 80 N.Y.U. L. REV. 513, 533–44 (2005).

168. 12 U.S.C. § 2901(b) (2006) (emphasis added).169. 123 CONG. REC. 17,630 (1977) (statement of Sen. William Proxmire).



banks received: exclusive charter powers, deposit insurance, anddiscount loans.170

So, what is it about this law that makes it a favorite target ofthose who would lay the blame for the crisis on it and those minor-ity communities which the CRA supposedly directs banks to serve?Under the CRA,171 bank regulators grade the financial institutionsthe CRA covers on those institutions’ success in meeting the creditneeds of their communities, including low- and moderate-incomeneighborhoods, consistent with safe and sound banking prac-tices.172 Bank regulators are then supposed to take into accountthat grade when a bank makes an application to its regulators totake certain actions, like merging with another bank or opening abank branch.173 If the CRA were some kind of sword of Damocleshanging over the heads of banks, forcing them to make unwiseloans, we would likely see two things: first, the regulators givingbanks poor CRA ratings; and second, the regulators rejecting bank

170. See 123 CONG. REC. 1,958 (1977) (statement of Sen. William Proxmire).For a further discussion of the connection between government support for banksand the CRA, see Barr, supra note 167, at 616–24 (2005); Allen J. Fishbein, TheCommunity Reinvestment Act After Fifteen Years: It Works, but Strengthened Federal Enforce-ment Is Needed, 20 FORDHAM URB. L.J. 293, 293 (1993) (citation omitted).

171. Under the CRA, the following federal banking agencies supervise differ-ent sectors of the banking industry: the Office of the Comptroller of the Currencyoversees national banks; the Board of Governors of the Federal Reserve Systemoversees state chartered banks which are members of the Federal Reserve Systemand bank holding companies; the Federal Deposit Insurance Corporation regu-lates state chartered banks, savings banks that are not members of the FederalReserve System and the deposits insured by the FDIC; and the Office of ThriftSupervision (OTS) with respect to savings associations, the deposits of which areinsured by the FDIC and savings and loan holding companies. 12 U.S.C. § 2902(1)(2006). With the dissolution of the OTS through the Dodd-Frank financial reformlegislation, it is likely that the OCC will assume CRA responsibilities over many ofthe former OTS-regulated entities. Dodd-Frank Wall Street Reform and ConsumerProtection Act, Pub. L. No. 111-203, § 312, 124 Stat. 1376, 1521–23 (2010).

172. 12 U.S.C. § 2906(a)(1) (2006). Regulators issue one of four “grades” tothe institutions they oversee based on those institutions’ success in “meeting com-munity credit needs” consistent with the CRA: “outstanding,” “satisfactory,” “needsto improve,” or “substantial noncompliance.” Id. § 2906(b)(2).

173. Under the CRA, a federal bank must take into account a covered bank’sCRA record whenever the bank applies to its regulator for a “deposit facility.” 12U.S.C. § 2903(a)(2) (2006). The statute defines such an application to include arequest seeking approval for any of the following: “a charter for a national bank orFederal savings and loan association; . . . deposit insurance in connection with anewly chartered . . . bank”; the establishment of a branch or other facility that willaccept deposits; the relocation of a home or branch office; or the merger, consoli-dation, or acquisition of another regulated financial institution in certain circum-stances. Id. § 2902(3).



applications on CRA grounds with great frequency. In reality, in thelead up to the financial crisis, neither of these occurred.

First, in terms of regulators issuing bank CRA grades, in 2005, ayear in which many financial institutions engaged in risky lendingpractices, 99% of all banks covered by the CRA received a grade of“satisfactory” or “outstanding” in terms of meeting their CRA obli-gations.174 Second, in terms of bank applications, during the 15year span from 1985 to 1999, only eight bank applications were de-nied by bank regulators on any grounds, a figure that might seemsignificant until one learns that there were over 92,000 applicationssubject to CRA review that were filed during that period.175 Analysisof the Federal Reserve’s record shows that, from 1988 through2007, the Federal Reserve denied only eight bank applications ofthe more than 13,000 filed with it for unsatisfactory efforts to meetcommunity needs or to provide consumer protection.176

It is hard to imagine that the enforcement mechanisms, as ap-plied by the regulators, were a meaningful check on bank behavior.Putting aside whether the CRA, as structured and enforced, was aserious check on the behavior of the banks to which the CRA ap-plied, the truth of the matter is that the overwhelming majority ofthe riskiest bank behavior during the subprime mortgage market’sheyday took place beyond the CRA’s reach. As stated previously, thelegislative history of the CRA reveals that it was enacted as a re-sponse to two forces in the market: redlining and credit exporta-tion. As a result, the CRA covers only depository institutions andconcerns itself with the geographic focus of bank activities as theyrelate to those places where a covered financial institution does thebulk of its business.177 The CRA was thus conceived in a very differ-ent time, before internet and global banking, when the neighbor-hood bank was where one deposited one’s money and soughtaccess to credit. Given this history, the CRA was ill-equipped to han-dle the subprime tsunami that hit in the early part of this decade. Areview of its scope reveals that the CRA exempted much of the riski-

174. The Community Reinvestment Act: Thirty Years of Accomplishments, but Chal-lenges Remain: Hearing Before the H. Comm. on Fin. Servs., 110th Cong. 194 (2008)(statement of John Taylor, President and CEO, Nat’l Cmty. Reinvestment Coal.).

175. See Barr, supra note 167, at 586 (citing TREASURY DEP’T, APPLICATIONS

SUBJECT TO CRA THAT WERE SUBJECT TO CRA THAT WERE PROTESTED ON CRAGROUNDS (2000)).

176. Foreclosures at the Front Step of the Federal Reserve Bank of Cleveland: HearingBefore the Subcomm. on Domestic Policy of the H. Comm. on Oversight and Gov’t Reform,110th Cong. 63–64 (2007) (statement of Sandra Braunstein, Director, Div. of Con-sumer and Cmty. Affairs, Fed. Reserve Sys.).

177. See infra notes 178–84 and accompanying text.



est lending that took place in this time from its coverage in a num-ber of ways. As a result of this narrow CRA scope, it is hard to arguethat the CRA forced financial institutions that it did not even coverto do anything.

According to the statute, the CRA only applies to “regulatedfinancial institutions,”178 which the statute describes as “insured de-pository institution[s].”179 This is the largest exemption, which, ac-cording to Fed Chairman Bernanke, excluded during the recentexpansion of the market as much as two-thirds of mortgage lendingfrom the CRA’s reach.180 That is the share of mortgage lendingduring that time that was carried out by standalone mortgage com-panies, companies that did not take deposits and thus were not cov-ered by the CRA.181 A second exemption permits depositoryinstitutions, at their discretion, to exempt the lending of their non-bank affiliates from CRA coverage, even if they are themselves cov-ered by the law.182 Thus, a bank like Bank of America can exemptits subsidiary, Countrywide, from CRA coverage if it chooses.

Third, the requirements of the CRA only apply to bank activi-ties within each bank’s “assessment areas” and regulators assess abank’s lending in low- and moderate-income communities onlywithin those assessment areas.183 A bank’s assessment area includeswhere it has offices and branches, and where a “substantial” portionof a bank’s lending occurs.184 Regulators do not review lending for

178. 12 U.S.C. § 2901(a)(1) (2006).179. Id. § 2902(2). Under the CRA, the definition of “insured depository insti-

tution” is that set forth in 12 U.S.C. § 1813, which provides that such an institutionis “any bank or savings association the deposits of which are insured by the [Fed-eral Deposit Insurance] Corporation . . . .” Id. § 1813(c)(2).

180. Ben S. Bernanke, The Community Reinvestment Act: Its Evolution andNew Challenges, Speech at the Community Affairs Research Conference 5 (Mar.30, 2007), available at http://www.federalreserve.gov/newsevents/speech/bernanke20070330a.htm; see also ROBERT E. LITAN ET AL., THE COMMUNITY REIN-

VESTMENT ACT AFTER FINANCIAL MODERNIZATION: A BASELINE REPORT 70–72 (2000),available at http://www.novoco.com/low_income_housing/resource_files/research_center/crareport.pdf (analyzing lending data from 1992 and 1998, andfinding that two-thirds of the increase in lending by institutions not covered by theCRA to low- and moderate-income communities was attributable to lenders special-izing in subprime, while only 15% of these loans were originated by CRA-coveredinstitutions).

181. Bernanke, supra note 180 (noting that companies owned by banks orbank holding companies can be nondepository institutions).

182. See Richard D. Marsico, Subprime Lending, Predatory Lending, and the Com-munity Reinvestment Act Obligations of Banks, 46 N.Y.L. SCH. L. REV. 735, 738–39(2003) (citing 12 CF.R. § 25.22(a)(1), (c)(1) (2010).

183. See 12 C.F.R. §§ 25.22, 25.41 (2010).184. See id. § 25.41 (2010).



its consistency with CRA goals when lending activity is conducted bycovered financial institutions and occurs outside their assessmentareas. Thus, even a covered institution can engage in predatorypractices beyond the reach of the CRA simply by doing a less thansubstantial amount of lending in communities where they have nobranches. Given the age of internet banking, this is fairly easy to do.Another way of looking at this is to say that the CRA was irrelevantto lending that took place outside of covered financial institutions’designated CRA assessment areas; as a result, risky lending that oc-curred outside of these areas could not have been driven by theCRA simply because the CRA did not cover such lending.

These exclusions from the CRA—i.e., that it covers only finan-cial institutions that take deposits, bank subsidiaries that do notthemselves take deposits at those parent banks’ discretion, andlending in a covered bank’s assessment area—leave gaping holes inCRA coverage. These gaps in coverage were particularly relevant tothe expansion of subprime lending in the lead up to the financialcrisis. In fact, a study by the Federal Reserve showed that at least94% of all subprime lending during the height of the mortgagemania was outside the scope of the CRA.185 Moreover, numerousstudies have shown that CRA lending was actually as profitable andviable as other stable loans on banks’ ledgers, and potentially lesslikely to enter into foreclosure than subprime loans.186

185. Memorandum from Glenn Canner & Neil Bhutta, Div. of Research andStatistics, Bd. of Governors of the Fed. Res. Sys., to Sandra Braunstein, Dir., Con-sumer & Cmty. Affairs Div., Bd. of Governors of the Fed. Reserve Sys. 3 (Nov. 21,2008), available at http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf. It is also important to note that the 94% figure might actually under-estimate the number of subprime loans that the CRA covered during the buildup ofthe subprime mortgage market: i.e., that figure might be lower than 6%. The Can-ner & Bhutta report did not differentiate between loans made by CRA-coveredinstitutions and loans made by their affiliates. Thus, this percentage includes thelending carried out by affiliates of CRA-covered entities, which, as mentionedabove, would only have been covered by the CRA at the discretion of the parentinstitution.

186. See Canner & Bhutta, supra note 185, at 10 tbl.7. A study by the FederalReserve Bank of San Francisco of the loans issued in California from 2004 through2006, the height of the boom in that state, revealed that mortgage loans made toborrowers of similar creditworthiness by financial institutions covered by the CRA,in those institutions’ assessment areas, were half as likely to enter foreclosure asloans made by independent mortgage lenders not covered by the CRA. ElizabethLaderman & Carolina Reid, CRA Lending During the Subprime Meltdown, in FED. RE-

SERVE BANKS OF BOS. AND S.F., REVISITING THE CRA: PERSPECTIVES ON THE FUTURE

OF THE COMMUNITY REINVESTMENT ACT 115, 118, 122 (2009), available at http://www.frbsf.org/publications/community/cra/revisiting_cra.pdf. On the profitabil-ity of lending covered by the CRA prior to the buildup of the subprime mortgage



In the end, the indictment against the CRA is not that it wastoo strong, but that it was too weak. Built to fight the civil rightsbattles of the twentieth century, in which communities were red-lined and excluded from traditional bank services and access tocapital, it was ill-equipped to withstand the cascade of subprimelenders that flourished in certain communities. Such lenders suc-ceeded precisely because of a legacy of discrimination in those com-munities that meant fewer legitimate bank options were availablethere.187 Remember those 169 failed lending institutions discussedabove?188 One hundred sixty-seven of them, roughly 99%, were be-yond the reach of the CRA because they were non-depository insti-tutions and thus not covered by the CRA.189 It is hard to lay theblame on the CRA when 94% of subprime lending took placeoutside its scope, and 99% of the riskiest lenders were not evencovered by it.

B. The Role of Government Sponsored Entities

Turning to the GSEs, the theory goes that politicians drovethose entities to increase their share of the subprime securitizationpool, which led to an unsustainable expansion of the mortgagemarket, reaching borrowers that were poor credit risks.190 But thefacts concerning the GSEs’ share of the market do not bear this out.Indeed, as the securitization market expanded in 2004 and 2005,both the size and the share of the GSEs’ stake in that market actu-ally declined. As the market started to dry up in 2006, their sharegot even smaller, as Table 17 reveals.

market, see BD. OF GOVERNORS OF THE FED. RESERVE SYS., THE PERFORMANCE AND

PROFITABILITY OF CRA-RELATED LENDING 45–51 (2000), available at http://www.federalreserve.gov/boarddocs/surveys/craloansurvey/cratext.pdf.

187. See, e.g., Kathleen C. Engel & Patricia A. McCoy, The CRA Implications ofPredatory Lending, 29 FORDHAM URB. L.J. 1571, 1583–84 (2001) (noting that failureof traditional lenders to serve communities of color allows predatory lenders tocharge supracompetitive rates); see also Barr, supra note 167, at 534–40 (2005)(providing economic reasons for failure of mortgage market to serve certaincommunities).

188. See supra text accompanying notes 145–46.189. See Avery et al., supra note 145, at A123.190. See RAJAN, supra note 83, at 32–45.



Table 17: GSE Share of All Subprime Securities, 2004–2006.191

Furthermore, although the GSEs did lower their underwritingstandards in the early part of this decade, recent research by theNational Community Reinvestment Coalition reveals that securi-tized subprime loans on the books of private investors, as comparedto those on the GSEs’ ledgers, were more than twice as likely to gointo default.192 Thus, if risky lending and poor underwriting stan-dards are to blame for the present foreclosure crisis, then had theunderwriting standards of the securitizations that the GSEs investedin been utilized across the board, foreclosure rates may have beensignificantly reduced.193

191. See Carol D. Leonnig, How HUD Mortgage Policy Fed the Crisis: SubprimeLoans Labeled ‘Affordable’, WASH. POST (June 10, 2008), http://www.washingtonpost.com/wp-dyn/content/article/2008/06/09/AR2008060902626.html.

192. See Jayasundera et al., supra note 161, at 3, 18 tbl.6.193. See id. at 20. A related issue recently reached the Supreme Court, where

the Court upheld the authority of state attorneys general to enforce their respec-tive states’ fair lending laws. Cuomo v. Clearing House Ass’n, 129 S. Ct. 2710, 2717,2722 (2009) (holding that National Bank Act only preempts sovereign’s “vistorialpowers” and not its ability to enforce its own fair-lending laws).



It seems likely that non-depository institutions and private in-vestors were driving the riskiest lending, not a political push gener-ated by Washington through either the CRA or the GSEs.

IV.MOVING FORWARD: SOCIAL DISTANCE AND

FINANCIAL REFORM

The preceding analysis raises important questions about theimpact of racial and economic inequality on the health of nationaleconomies and the sustainability of certain economic practices.Given these impacts, efforts to rein in risky practices should takeinto account the way social inequalities, and the social distance theyengender, can increase predatory conduct and weaken markets.There are several straightforward, macroeconomic approaches thatcould help to reduce social distance. Recalibrating marginal taxrates so as to increase taxes on the wealthy as a way to flatten differ-ences between the haves and have-nots is one obvious way to reducethe social distance that comes from greater economic and socialinequality. If economic inequality itself is not subject to direct as-sault, given political realities, the gravity of Judson’s “governanceproblem” can be reduced by reducing the influence of money onthe political process, though the present makeup of the U.S. Su-preme Court holds a firm line against campaign finance reform.194

Short of a constitutional amendment, the outsized influence ofmoney on politics seems firmly in place. Similarly, governmentalaffirmative action strategies aimed at reducing economic inequalitybetween Whites and people of color have raised fatal constitutionalquestions.195 Yet with respect to racial inequality and the way it has

194. Andre Douglas Pond Cummings, Procuring “Justice”?: Citizens United,Caperton, and Partisan Judicial Elections, 95 IOWA L. REV. BULL. 89 (2010), availableat http://www.uiowa.edu/~ilr/bulletin/ILRB_95_cummings.pdf. The authornotes that especially since the holding in the Citizens United case, the Court has“[made] permissible a corporations direct expenditure of general treasury fundsto explicitly endorse or malign a candidate for public office immediately prior toan election.” Id. at 97 (citing Citizens United v. Fed. Election Comm’n, 130 S. Ct.876, 964 (2010) (Stevens, J., concurring in part and dissenting in part)). This un-willingness to tighten campaign financing practices has been an identifiable trendin the U.S. Supreme Court since Chief Justice Roberts took his position. See Rich-ard Briffault, WRTL and Randall: The Roberts Court and the Unsettling of CampaignFinance Law, 68 OHIO ST. L.J. 807, 807–08 (2007) (stating that two decisions madein Roberts’ first year as Chief Justice “may constitute a pivotal moment in theCourt’s evolving campaign finance jurisprudence”).

195. For a discussion of the constitutional barriers to public affirmative actionstrategies, see Jed Rubenfeld, Affirmative Action, 107 YALE L.J. 427, 428–30 (1997).The author asserts that “[t]he ultimate constitutional question presented by race-



played out in the mortgage arena, the legal infrastructure thatmight combat reverse redlining exists, but application of the lawsagainst discrimination in lending during the last decade seems slowto catch up to invidious practices. This is due not only to the inade-quacy of enforcement mechanisms and resources, but also to thefact that securitization permits downstream investors to claim pro-tection from charges of discrimination in the origination of the un-derlying mortgages by invoking the “holder in due course”doctrine.196

Since economic and racial inequality seem to bear some rela-tion to financial crises, short of direct efforts to reduce such ine-quality—efforts that might seem politically infeasible orconstitutionally suspect—to what extent does the recent financialreform legislation that Congress passed in the summer of 2010 ad-dress these forms of social inequality, if at all? The remainder ofthis section is devoted to this question, as well as to the question ofwhether there are additional legislative or market-oriented fixes,not covered in this legislation, that might rein in the effects of so-cial inequality.

In July 2010, by a close—yet bi-partisan—vote, Congress passedwhat became known as the Dodd-Frank bill, named for ConnecticutSenator Chris Dodd and Massachusetts Representative BarneyFrank, both Democrats. Formally known as the “Dodd-Frank WallStreet Reform and Consumer Protection Act,” the legislation runsover 2000 pages and covers a wide range of topics, including in-creasing transparency in derivatives trading, improving regulatoryoversight over financially important institutions, and strengtheningregulatory authority to wind down institutions that pose systemicrisks to the financial system.197 At the same time, few in the general

based affirmative action—by no means an easy question—is whether whites’ equalprotection rights are violated when the government purposefully acts to assistblacks and other minorities by granting them special opportunities.” Id. at 429.

196. Put in its most basic form, the holder in due course doctrine protects apurchaser of a financial instrument who buys that instrument for value withoutnotice of any defects in prior transactions related to that instrument. For a descrip-tion of the holder in due course doctrine, see Vern Countryman, The Holder in DueCourse and Other Anachronisms in Consumer Credit, 52 TEX. L. REV. 1, 2–3 (1973). Forcriticisms of the doctrine, specifically as it relates to the securitization of subprimemortgages, see Kurt Eggert, Held Up in Due Course: Predatory Lending, Securitization,and the Holder in Due Course Doctrine, 35 CREIGHTON L. REV. 503 (2002); SiddharthaVenkatesan, Note, Abrogating the Holder in Due Course Doctrine in Subprime MortgageTransactions to More Effectively Police Predatory Lending, 7 N.Y.U. J. LEGIS. & PUB.POL’Y 177 (2003).

197. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.No. 111-203, 124 Stat. 1376 (2010).



public appear to have faith in the legislation to prevent future fi-nancial crises from occurring.198 Moreover, the legislation does lit-tle to address the problem of economic and racial inequality andthe social distance they create. In this section, those aspects of theDodd-Frank legislation that appear to relate in some way to the ine-qualities discussed in previous sections are analyzed.

What follows is an exploration of some of the issues implicatedby the analysis set forth above, and an attempt to identify potentialareas of focus for regulators as they begin the difficult process ofdeveloping the regulations necessary to implement Dodd-Frank, aswell as continue the investigation of predatory conduct that oc-curred during the lead up to the financial crisis. This analysis alsoidentifies potential areas of focus for the new Consumer FinancialProtection Bureau. Each of these topics will be discussed, in turn,below.

In addition, as this Article goes to print, Congress is expectedto consider what could amount to wide-ranging amendments to theCRA, changes that would expand its coverage and close the loop-holes that left much of the riskiest lending outside its coverage.This Article discusses these proposed amendments below. Finally,this section concludes with a discussion of the role that social capi-tal can play in improving financial industry practices, with particu-lar emphasis on its ability to serve as a consumer-driven lever forreform of the financial sector, regardless of the relative effective-ness of Dodd-Frank to rein in the riskiest, crisis-inducing practicesof the shadow banking system.

A. Social Distance, Dodd-Frank, and a New Regulatory Framework

Not surprisingly, perhaps, Dodd-Frank explicitly says next tonothing about social inequality. Only in section 1204, entitled “Ex-panded Access to Mainstream Financial Institutions,” is any refer-ence made to low- and moderate-income individuals. This sectionauthorizes the Secretary of the Treasury to undertake the following:

198. A Bloomberg poll conducted on the eve of the passage of the Dodd-Frank legislation found the following:

Almost four out of five Americans surveyed in a Bloomberg National Poll thismonth say they have just a little or no confidence that the measure beingchampioned by congressional Democrats will prevent or significantly soften afuture crisis. More than three-quarters say they don’t have much or any confi-dence the proposal will make their savings and financial assets more secure.

Rich Miller, Wall Street Fix Seen Ineffectual by Four of Five in U.S., BLOOMBERG, July 13,2010, http://www.bloomberg.com/news/2010-07-13/wall-street-fix-from-congress-seen-ineffectual-by-four-out-of-five-in-u-s-.html.



to establish a multiyear program of grants, cooperative agree-ments, financial agency agreements, and similar contracts orundertakings to promote initiatives designed—

(1) to enable low- and moderate-income individuals to es-tablish one or more accounts in a federally insured depositoryinstitution that are appropriate to meet the financial needs ofsuch individuals; and

(2) to improve access to the provision of accounts, on rea-sonable terms, for low- and moderate-income individuals.199

Apart from this lone explicit mention, there are also other pro-visions in the legislation that will assist low- and moderate-incomecommunities. For example, the legislation authorizes the TreasurySecretary to assess the risk to consumers from consumer financialproducts and services200 and to promote programs that will offeralternatives to high-cost, small dollar loans;201 adopts mortgage pro-tections geared towards ensuring that mortgage originators offerloan products that are appropriate for the borrowers they serve;202

and places limits on mortgage broker compensation to ensure thatbrokers are not given incentives to steer borrowers into higher costand less favorable loans.203 Each of these provisions will undoubt-edly assist lower-income Americans. Moreover, the Bureau of Con-sumer Financial Protection will likely be inclined towards ensuringthat lower-income Americans are not preyed upon by financial insti-tutions using opaque and predatory products.204 The creation ofthis entity is probably the most significant aspect of the Dodd-Franklegislation that will impact social inequality, and the following sec-tion provides an overview of the bureau’s powers and functions.

At the same time, Dodd-Frank does little to rein in executivecompensation at regulated financial institutions. It is hard to thinkof a practice that did more to spur economic inequality, and the

199. Dodd-Frank Wall Street Reform and Consumer Protection Act§ 1204(a)(2).

200. Id. § 1024(b)(1)(C).201. Id. § 1205(a).202. Id. § 1402–33.203. Such incentives, typically called “Yield Spread Premiums,” often en-

couraged brokers to try to convince borrowers to accept more expensive loanterms because the broker was paid a higher commission for doing so. On the oper-ation of these premiums, see Howell E. Jackson & Laurie Burlingame, Kickbacks orCompensation: The Case of Yield Spread Premiums, 12 STAN. J.L. BUS. & FIN. 289(2007).

204. A discussion of the Consumer Financial Protection Bureau follows infraPart IV.A.1.



Judsonian governance problem mentioned earlier,205 than thegrowth of financial compensation for financial industry execu-tives.206 What Dodd-Frank does do in this area is direct the develop-ment of regulations that will prohibit “excessive compensation” thatcould lead to excessive risk-taking at a large percentage of financialsector institutions.207 These regulations will cover a range of institu-tions, including bank holding companies, registered broker deal-ers, and credit unions, among others.208 In many ways, these newstandards adopt similar controls to provisions already in existencerelated to excessive compensation controls on insured depositoryinstitutions.209

Other provisions of the legislation related to compensation in-clude non-binding “say on pay” votes for shareholders,210 disclosurerequirements on public companies,211 and compensation clawbackprovisions for companies that must restate earnings.212 It is tooearly to determine whether these regulations will have teeth andwhether regulators will enforce them vigorously.

The following discussion provides an overview of those otheraspects of the Dodd-Frank legislation, beyond the modest compen-sation controls described above, that relate most directly to socialinequality. In this discussion, this Article attempts to provide anoverview of both the legislation’s specific provisions as well as thecritical issues that will face regulators, the financial industry, andconsumers as the legislation moves from passage toimplementation.

1. The Bureau of Consumer Financial Protection

Dodd-Frank calls for the creation of an independent sub-agency within the Federal Reserve System that will have as its pri-mary function maintaining oversight of federal consumer protec-tion laws and monitoring the financial system for abusive andunfair practices. To be known as the “Bureau of Consumer Finan-

205. See supra text accompanying notes 65–67.206. For a discussion of the potential impacts of executive compensation

structures on the financial crisis, see Mark Hulbert, Did Bankers’ Pay Add to ThisMess?, N.Y. TIMES, Sept. 27, 2009, at BU6, available at http://www.nytimes.com/2009/09/27/business/27stra.html, and the sources cited therein.

207. Dodd-Frank Wall Street Reform and Consumer Protection Act § 956(b).208. Id. § 956(e).209. See 12 U.S.C. § 1831p-1(c) (2006).210. Dodd-Frank Wall Street Reform and Consumer Protection Act § 951.211. Id. § 953.212. Id. § 954.



cial Protection”213 (or, as it is more commonly referred to, the Con-sumer Financial Protection Bureau, or CFPB), the Bureau will drawits funding from the Federal Reserve System,214 and its director willbe nominated by the President and confirmed by the U.S.Senate.215

Section 1021 of Dodd-Frank lays out the CFPB’s purpose,objectives, and functions. According to the legislation, the bureaushall “seek to implement and, where applicable, enforce Federalconsumer financial law consistently for the purpose of ensuringthat all consumers have access to markets for consumer financialproducts and services and that markets for consumer financialproducts and services are fair, transparent, and competitive.”216

The Bureau is tasked with enforcing a range of federal financialprotection laws, including the Truth in Lending Act and the EqualCredit Opportunity Act.217

213. Id. § 1011(a).214. Id. § 1017(a).215. Id. § 1011(b)(3).216. Dodd-Frank Wall Street Reform and Consumer Protection Act

§ 1021(a).217. According to Dodd-Frank, the consumer protection laws that the bureau

has responsibility over include those laws designated as “enumerated consumerlaws,” which are the following:

(A) the Alternative Mortgage Transaction Parity Act of 1982 (12 U.S.C. 3801et seq.);(B) the Consumer Leasing Act of 1976 (15 U.S.C. 1667 et seq.);(C) the Electronic Fund Transfer Act (15 U.S.C. 1693 et seq.), except withrespect to section 920 of that Act;(D) the Equal Credit Opportunity Act (15 U.S.C. 1691 et seq.);(E) the Fair Credit Billing Act (15 U.S.C. 1666 et seq.);(F) the Fair Credit Reporting Act (15 U.S.C. 1681 et seq.), except with respectto sections 615(e) and 628 of that Act (15 U.S.C. 1681m(e), 1681w);(G) the Home Owners Protection Act of 1998 (12 U.S.C. 4901 et seq.);(H) the Fair Debt Collection Practices Act (15 U.S.C. 1692 et seq.);(I) subsections (b) through (f) of section 43 of the Federal Deposit InsuranceAct (12 U.S.C. 1831t(c)–(f));(J) sections 502 through 509 of the Gramm-Leach-Bliley Act (15 U.S.C. 6802-6809) except for section 505 as it applies to section 501(b);(K) the Home Mortgage Disclosure Act of 1975 (12 U.S.C. 2801 et seq.);(L) the Home Ownership and Equity Protection Act of 1994 (15 U.S.C. 1601note);(M) the Real Estate Settlement Procedures Act of 1974 (12 U.S.C. 2601 etseq.);(N) the S.A.F.E. Mortgage Licensing Act of 2008 (12 U.S.C. 5101 et seq.);(O) the Truth in Lending Act (15 U.S.C. 1601 et seq.);(P) the Truth in Savings Act (12 U.S.C. 4301 et seq.);(Q) section 626 of the Omnibus Appropriations Act, 2009 (Public Law111–8); and



“The Bureau is authorized to exercise its authorities underFederal consumer financial law” to ensure that consumers are giveneffective information about consumer products and services,218 and“consumers are protected from unfair, deceptive, or abusive actsand practices and from discrimination.”219 The Bureau is also em-powered to address “unduly burdensome regulations . . . in order toreduce unwarranted regulatory burdens.”220 It should also ensurefair competition among depository and non-depository institutionsand that “consumer financial products and services operate trans-parently and efficiently to facilitate access and innovation.”221 The“primary functions” of the Bureau will include engaging in con-sumer education; “collecting, investigating, and responding to con-sumer complaints;” monitoring markets to “identify risks toconsumers and the proper functioning of such markets;” supervis-ing compliance with and enforcing consumer protection laws; andissuing rules, orders, and guidance on consumer protection laws.222

With respect to rulemaking, the CFPB will have the primaryenforcement authority over the federal consumer protection lawsover which it has jurisdiction.223 At the same time, the FinancialStability Oversight Council,224 also created by Dodd-Frank,225 hasthe ability to stay or set aside any rules promulgated by the Bureau

(R) the Interstate Land Sales Full Disclosure Act (15 U.S.C. 1701).Id. §§ 1002(12)(A)–(R), 1002(14), 1011(a).

218. Id. § 1021(b).219. Id. § 1021(b)(2).220. Id. § 1021(b)(3).221. Id. § 1021(b)(4), (5).222. Id. § 1021(c)(1)–(5).223. Id. § 1025(c).224. The Council will include the following voting members:

(A) the Secretary of the Treasury, who shall serve as Chairperson of theCouncil;(B) the Chairman of the Board of Governors;(C) the Comptroller of the Currency;(D) the Director of the Bureau;(E) the Chairman of the Commission;(F) the Chairperson of the Corporation;(G) the Chairperson of the Commodity Futures Trading Commission;(H) the Director of the Federal Housing Finance Agency;(I) the Chairman of the National Credit Union Administration Board; and(J) an independent member appointed by the President, by and with the ad-vice and consent of the Senate, having insurance expertise.

Id. § 111(b)(1).225. Id. § 111(a).



on an affirmative vote of two thirds of the members of theCouncil.226

In addition, the Bureau can hold hearings and adjudicativeproceedings concerning alleged violations of consumer protectionlaws,227 can file litigation in its own name,228 and is to create a fundto collect penalties and fines for violations of consumer protectionlaws to help to compensate victims of such violations.229

It is apparent that the focus of the CFPB will be to minimizeinformation asymmetries, monitor the functioning of markets andthe use of dangerous financial products, enforce federal consumerprotection laws, and prosecute violations of these laws. These pow-ers will likely inure to the benefit of individuals of low and moder-ate income the most, or those most susceptible to deceptivepractices and those most in need of assistance guarding againstsuch practices. In this way, the Bureau has the potential to be astrong counterweight to the significant financial and informationaladvantages that well-heeled institutions and intermediaries haveover less sophisticated consumers. With so much primary authorityover federal consumer protection laws, for such things as rulemak-ing and enforcement, it is critical that the CFPB is staffed with indi-viduals who will take their role seriously, and will be aggressive andconscientious in carrying out the mandate and mission of the en-tity. Resting such broad, primary and comprehensive consumerprotection authority in a single entity runs the risk that such powerwill not be wielded well or, worse, will give consumers a false senseof security, leading the way for deceptive practices that are moreeffective in taking advantage of consumers. “Cognitive regulatorycapture” of the CFPB by individuals inclined to favor industry inter-ests could, in fact, do more harm than good.230 Thus, ensuring that

226. Id. § 1023(c)(3)(A) (setting forth the two-thirds requirement). With re-spect to the specific authority to overturn a bureau’s rule, Section 1023(a) providesas follows:

Review of Bureau Regulations.—On the petition of a member agency of theCouncil, the Council may set aside a final regulation prescribed by the Bu-reau, or any provision thereof, if the Council decides, in accordance with sub-section (c), that the regulation or provision would put the safety andsoundness of the United States banking system or the stability of the financialsystem of the United States at risk.

Id. § 1023(a).227. Id. § 1053(a).228. Id. § 1054(b).229. Id. § 1017(d).230. For a discussion of cognitive regulatory capture, in which regulators

adopt the mindset and interests of the entities they regulate, see WILLEM H.



the agency is staffed by individuals with independence and who pos-sess the ability to navigate and coordinate the efforts of dozens offederal agencies will be an essential first step in guaranteeing thesuccess of the CFPB in carrying out its purposes and helping to mit-igate the effects of social distance. One aspect of this mission—theCFPB’s fair lending enforcement powers—will obviously be essen-tial in addressing the effects of social distance. This authority willnow be considered.

2. Strengthened Fair Lending Enforcement

Dodd-Frank mandates that the Bureau create an Office of FairLending and Equal Opportunity.231 The powers of this Office in-clude any that the Bureau Director may delegate to it, including thefollowing:

(A) providing oversight and enforcement of Federal laws in-tended to ensure the fair, equitable, and nondiscriminatory ac-cess to credit for both individuals and communities that areenforced by the Bureau, including the Equal Credit Opportu-nity Act and the Home Mortgage Disclosure Act;(B) coordinating fair lending efforts of the Bureau with otherFederal agencies and State regulators, as appropriate, to pro-mote consistent, efficient, and effective enforcement of Fed-eral fair lending laws;(C) working with private industry, fair lending, civil rights, con-sumer and community advocates on the promotion of fairlending compliance and education; and(D) providing annual reports to Congress on the efforts of theBureau to fulfill its fair lending mandate.232

Along a similar vein, earlier this year the Department of Justice(DOJ) announced the creation of a new Fair Lending Unit withinthe Department’s Civil Rights Division that will focus on discrimina-tory lending occurring now and in the lead up to the financialcrisis.233

Given the fact that unfair lending was prevalent during themortgage mania of the last decade, there is an obvious need for this

BUITER, LESSONS FROM THE NORTH ATLANTIC FINANCIAL CRISIS 37 (2008), availableat http://www.newyorkfed.org/research/conference/2008/rmm/buiter.pdf.

231. Dodd-Frank Wall Street Reform and Consumer Protection Act§ 1013(c)(1).

232. Id. § 1013(c)(2)(A)–(D).233. Thomas E. Perez, Assistant Att’y Gen., Testimony Before the H. Sub-

comm. on the Constitution, Civil Rights, and Civil Liberties (Apr. 29, 2010), availa-ble at http://www.justice.gov/crt/speeches/2010/crt-speech-100429.html.



type of focus for the CFPB, as well as for the DOJ. These two entitiesshould join forces with others both inside and outside the federalgovernment to conduct a comprehensive assessment of lendingpractices during the lead up to the financial crisis. With the out-standing portfolios of Fannie Mae and Freddie Mac, those of thebanks the FDIC has taken over in the last two years, and the recordsthe Department of the Treasury has amassed through its mortgagemodification program, there is a wealth of data available to theCFPB and the DOJ to identify discriminatory lending patterns. Ifmany of the lenders responsible for the worst abuses have since dis-solved, at least such investigations will help to uncover the extent towhich discrimination may have played a part in the buildup of themortgage market. Such information is critical to help develop adeeper appreciation for the causes of the crisis; to date, little hasbeen done to root out such information, short of the efforts of afew plaintiff-side attorneys and intrepid state attorneys general.

Placing primary enforcement authority over such laws as theEqual Credit Opportunity Act and the Home Mortgage DisclosureAct with the CFPB means there is now a federal financial regulatorwith a primary focus on fair lending. This will help address one ofthe critical causes of social distance that played itself out with feroc-ity in the lead up to the financial crisis: economic inequality thatfalls along racial lines. In order to minimize the harshest conse-quences of this social distance, robust enforcement of the fair lend-ing laws is necessary. Once again, in order for the CFPB to wieldthis authority in an effective way, it must be staffed by committed,competent and professional bureaucrats who will enforce both theletter and the spirit of the fair lending laws.

3. Reforming Mortgage Laws

Dodd-Frank imposes sweeping new restrictions on all homemortgage loans. Section 1411 of the legislation imposes the follow-ing requirement on residential mortgage lending:

[N]o creditor may make a residential mortgage loan unless thecreditor makes a reasonable and good faith determinationbased on verified and documented information that, at thetime the loan is consummated, the consumer has a reasonableability to repay the loan, according to its terms, and all applica-



ble taxes, insurance (including mortgage guarantee insur-ance), and assessments.234

This requirement is similar to the suitability requirement ap-plied in the securities context.235 A “reasonableness” requirementcould go a long way towards offsetting the asymmetries of informa-tion that plagued the mortgage market during the last decade.Such asymmetries left borrowers at the mercy of mortgage brokersand originators who could mask the true import of mortgage terms,including critical interest rate adjustment formulas.

The mortgage context is one in which the design of the lawsdoes not match the needs of many consumers. In this context, todate, we have relied heavily on a disclosure regime, one whichplaces a great deal of somewhat murky information at the disposalof the borrower.236 Such a regime clearly failed; it was and is ill-suited to the task of reining in the modern, at times exotic, mort-gage market.

If one traces the history of the development of other areas ofproperty law, the law has been transformed to take into account therealities of the day.237 The warranty of habitability is perhaps thebest example. In the landlord–tenant context, history shows that

234. Dodd-Frank Wall Street Reform and Consumer Protection Act§ 1411(a)(2) (amending Chapter 2 of the Truth in Lending Act, 15 U.S.C. § 1631et seq. (2006)).

235. For an overview of the suitability requirement with respect to the securi-ties industry, see Suitability, SEC. & EXCH. COMM’N, http://www.sec.gov/answers/suitability.htm (last modified Oct. 16, 2009).

236. For an analysis of the failure of the mortgage lending disclosure regimeto protect against abuses in the subprime mortgage market, see Jeff Sovern,Preventing Future Economic Crises Through Consumer Protection Law or How the Truth inLending Act Failed the Subprime Borrowers (St. John’s Univ. Sch. of Law, Legal StudiesResearch Paper No. 10-0189, 2010) available at http://ssrn.com/abstract=1531781.

237. That our property laws are constantly evolving is beyond question, asJustice Stevens, in his dissenting opinion in Lucas v. S.C. Coastal Council, 505 U.S.1003 (1992), made clear:

The human condition is one of constant learning and evolution—both moraland practical. Legislatures implement that new learning; in doing so theymust often revise the definition of property and the rights of property owners.Thus, when the Nation came to understand that slavery was morally wrongand mandated the emancipation of all slaves, it, in effect, redefined “prop-erty.” On a lesser scale, our ongoing self-education produces similar changesin the rights of property owners: New appreciation of the significance of en-dangered species, see, e. g., Andrus v. Allard, 444 U.S. 51 (1979); the impor-tance of wetlands, see, e. g., 16 U. S. C. § 3801 et seq.; and the vulnerability ofcoastal lands, see, e. g., 16 U. S. C. § 1451 et seq., shapes our evolving under-standings of property rights.

Id., at 1069–1070 (Stevens, J., dissenting).



the landlord–tenant relationship changed from one in which ajack-of-all-trades farmer entered into a relationship with a landowner, primarily for the use of farmland, to one in which an un-skilled tenant rented property in an urban setting.238 The law hadto adapt to take into account the inability of the tenant to tend tothe quality of his or her own housing and the inequity of bargainingpower between the landowner and the tenant.239

In the mortgage context, the disclosure regime, one in whichprospective borrowers received incomprehensible information withreferences to terms like “LIBOR” and the use of other methods tocalculate the interest rate on an adjustable rate mortgage, clearlyfailed and many borrowers accepted loans that they could not un-derstand with terms that were unsustainable.240

238. See Javins v. First Nat’l Realty, 428 F.2d 1071, 1078–79 (D.C. Cir. 1970),cert. den., 400 U.S. 925 (1970).

239. For a history of the development of the warranty of habitability, see MaryAnn Glendon, The Transformation of American Landlord-Tenant Law, 23 B.C. L. REV.503, 523–24 (1982). The sociological and economic forces at work that justifiedthe warranty of habitability’s transformation of the landlord-tenant relationshipare perhaps best summed up by Judge J. Skelly Wright’s opinion in the landmarkJavins v. First Nat’l Realty case. 428 F.2d 1071 (D.C. Cir. 1970). In his opinion, JudgeWright explained those forces as follows:

Today’s urban tenants, the vast majority of whom live in multiple dwellinghouses, are interested, not in the land, but solely in “a house suitable for occu-pation.” Furthermore, today’s city dweller usually has a single, specialized skillunrelated to maintenance work; he is unable to make repairs like the “jack-of-all-trades” farmer who was the common law’s model of the lessee. Further,unlike his agrarian predecessor who often remained on one piece of land forhis entire life, urban tenants today are more mobile than ever before. A ten-ant’s tenure in a specific apartment will often not be sufficient to justify effortsat repairs. In addition, the increasing complexity of today’s dwellings rendersthem much more difficult to repair than the structures of earlier times. In amultiple dwelling repair may require access to equipment and areas in thecontrol of the landlord. Low and middle income tenants, even if they wereinterested in making repairs, would be unable to obtain any financing formajor repairs since they have no long-term interest in the property.

Id. at 1078–79 (citations omitted).240. Mortgage disclosure laws were ill-suited to prepare borrowers with little

knowledge of sophisticated financial instruments to understand the terms of theirmortgages. See Aaron Smith, Note, A Suitability Standard for Mortgage Brokers: Develop-ing a Common Law Theory, 17 GEO. J. ON POVERTY L. & POL’Y 377, 389 (2010) (“Thevast majority of consumers would likely be considered unsophisticated in the de-tails of complex modern mortgages, with the possible exception of people who stillget standard fixed rate mortgages. Modern circumstances demand that mortgagebrokers not take advantage of this understandable reliance.”). For example, someadjustable mortgage rates were pegged to the London Interbank Offered Rate (LI-BOR), the floating rate at which banks borrow money from other banks on theLondon wholesale money market. See Alex M. Johnson, Jr., Preventing a Return En-



Moving forward, it is critical to recognize that a more robustbody of laws is necessary to protect borrowers in the real world. The“reasonable ability to repay” standard embodied in Dodd-Frank re-quires that mortgage originators and brokers must ensure that aparticular loan is appropriate for a particular borrower.241 This is alogical and necessary step to ensure that the mortgage feedingfrenzy fed by imbalances in the level of sophistication and knowl-edge between borrowers and lenders does not occur again. Admit-tedly, this would not protect any of the millions of borrowerspresently underwater, but it might help prevent the type of preda-tory conduct that appears to have been so prevalent before thecrisis.

4. Weakening Federal Preemption of State Consumer Protection Laws

Another important reform accomplished through Dodd-Frankis the partial rollback of efforts by several federal banking regula-tors to preempt state consumer protection laws. In the 1990s, theOffice of Thrift Supervision (OTS) was authorized to promulgateregulations pursuant to the Home Owners’ Loan Act (HOLA)242

that could preempt any state laws affecting “the operations of fed-eral savings associations.”243 The regulations could preempt anystate law that imposed licensing requirements on OTS-regulatedentities and attempted to regulate the interest rates such entitiescould charge.244 In 2003, the OTS issued letters declaring that fed-eral laws and regulations preempted state predatory lending laws asthey affected OTS-regulated entities in a range of states.245

gagement: Eliminating the Mortgage Purchasers’ Status as a Holder-In-Due-Course: ProperlyAligning Incentives Among the Parties, 37 PEPP. L. REV. 529, 572 nn.152–54 (2010)(providing relevant language present in Freddie Mac Single-Family Uniform In-strument for Multistate Initial Interest Adjustable Rate Notes). For a discussion ofthe connection between LIBOR and adjustable rate mortgages, see Bruce Yandle,Lost Trust: The Real Cause of the Financial Meltdown, 14 INDEP. REV. 341, 348 (2010);see also Olaf Clemens, Accounting Discretion, Securitization, and the Subprime Crisis: AnAccounting-based Analysis of the Subprime Market 22 (Jan. 15, 2010), available at http://www.fma.org/NY/Papers/AccountingDiscretionSecuritizationandSubprimeCri-sis.pdf.

241. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.No. 111-203, §§ 1402–03, 124 Stat. 1376, 2038–41 (2010).

242. 12 U.S.C. §§ 1461–70 (2006).243. 12 C.F.R. § 560.2(a) (2010).244. Id. § 560.2(b).245. Those states were: Georgia (see OFFICE OF THRIFT SUPERVISION, DEP’T OF

THE TREASURY, P-2003-1, PREEMPTION OF GEORGIA FAIR LENDING ACT (2003), availa-ble at http://files.ots.treas.gov/56301.pdf); New York (see OFFICE OF THRIFT SUPER-

VISION, DEP’T OF THE TREASURY, P-2003-2, PREEMPTION OF NEW YORK PREDATORY



In January 2004, the Office of the Comptroller of the Currency(OCC) followed the lead of the OTS and issued its own regulationsthat preempted state laws that “obstruct, impair, or condition a na-tional bank’s ability to fully exercise its Federally authorized realestate lending powers . . . .”246 This regulation preempted any statelaws that related to such matters as the terms of mortgages, escrowaccount requirements for loans, loan-to-value ratios, and a host ofother mortgage-related issues.247 The OCC also strengthened its ex-amination powers, declaring that it had the exclusive powers tovisit, examine, and inspect the banks under its supervision.248

The question of regulatory preemption ultimately reached theSupreme Court in 2006, with the Court siding with the federal regu-lators, finding that “state regulators [could not] interfere with the‘business of banking’ by subjecting [federally regulated] nationalbanks or their OCC-licensed operating subsidiaries to [state] auditsand surveillance under rival oversight regimes.”249 This decision ofthe Court, as one state attorney general pronounced, “took 50 sher-iffs off the beat at a time when lending was becoming the WildWest.”250

Even with a strong and independent consumer protection bu-reau, states should be authorized to regulate financial sector con-duct within their borders. If the delinquency and other datadiscussed here shows anything, it is that predatory conduct oc-curred at different rates and with different virulence in differentstates. As such, states must have the tools at their disposal to regu-late lending and other financial services when such servicesthreaten their citizens’ financial security.

Under Dodd-Frank, federal law as it relates to national bankswill only preempt state law under certain pre-conditions. First, astate consumer law will be preempted if its application will discrimi-

LENDING LAW (2003), available at http://files.ots.treas.gov/56302.pdf); New Jersey(see OFFICE OF THRIFT SUPERVISION, DEP’T OF THE TREASURY, P-2003-5, PREEMPTION

OF NEW JERSEY PREDATORY LENDING ACT (2003), available at http://files.ots.treas.gov/56305.pdf); and New Mexico (see OFFICE OF THRIFT SUPERVISION, DEP’T OF THE

TREASURY, P-2003-6, PREEMPTION OF NEW MEXICO HOME LOAN PROTECTION ACT

(2003), available at http://files.ots.treas.gov/56306.pdf).246. 12 C.F.R. § 34.4(a) (2010).247. Id.248. Id. § 7.4000(a).249. Watters v. Wachovia Bank, N.A., 550 U.S. 1, 21 (2007).250. Jo Becker et al., White House Philosophy Stoked Mortgage Bonfire, N.Y. TIMES,

Dec. 21, 2008, at A1 (quoting Roy Cooper, Att’y Gen. of N.C.).



nate against national banks in favor of state chartered banks.251 Sec-ond, preemption will apply if the state law “prevents or significantlyinterferes with” the national bank’s exercise of its charter pow-ers.252 In this way, the legislation returns federal preemption to itsstate prior to OCC and OTS preemption, consistent with the Su-preme Court’s decision in Barnett Bank of Marion County, N.A. v.Nelson.253 Or, third, state law will be preempted as it applies to na-tional banks if other federal laws expressly preempt the applicationof state laws to such national banks.254 Thus, if a state law does notmeet any of these criteria, state enforcement authorities can applyit to national banks. The law also exempts subsidiaries of nationalbanks (unless those subsidiaries themselves are chartered as na-tional banks) from the preemptive effect of Dodd-Frank.255

Curtailing the ability of federal regulators to preempt state lawswill go a long way towards permitting state legislatures, and the stateexecutive branch officials who enforce state laws, to adapt their lawsand to provide oversight over their state’s needs. Different marketscall for different responses, as well as experimentation with differ-ent types of consumer protection regimes. States should be allowedto carry out consumer protection activities without facing theshielding effects of federal preemption unless important issues offederalism—like protecting federally chartered institutions fromunfair competition from state-chartered institutions—are impli-cated by a particular state’s practices towards national banks actingwithin its borders.

251. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.No. 111-203, § 1044(a), 124 Stat. 1376, 2015 (2010) (creating 12 U.S.C. § 5136C).

252. Id.253. See 517 U.S. 25, 33 (1996).254. Dodd-Frank Wall Street Reform and Consumer Protection Act

§ 1044(a). For an analysis of the preemption pre-conditions, see Linda Singer etal., Breaking Down Financial Reform, 14 J. CONSUMER & COM. L. 2, 10–11 (2010); seealso Barnett, 517 U.S. at 31–33.

255. Dodd-Frank describes the application of preemption to subsidiaries ofnational banks as follows:

Notwithstanding any provision of this title or section 24 of Federal Reserve Act(12 U.S.C. 371), a State consumer financial law shall apply to a subsidiary oraffiliate of a national bank (other than a subsidiary or affiliate that ischartered as a national bank) to the same extent that the State consumerfinancial law applies to any person, corporation, or other entity subject tosuch State law.

Dodd-Frank Wall Street Reform and Consumer Protection Act § 1044(a).



B. The Community Reinvestment Modernization Act

After passage of the Dodd-Frank legislation, Congress consid-ered addressing CRA reform. In March of 2009, Rep. Eddie John-son introduced in the U.S. House of Representatives theCommunity Reinvestment Modernization Act of 2009 (CMRA).256

The goals of the CMRA are to close the CRA’s loopholes and toextend its coverage to a range of financial industry actors not cur-rently covered by the CRA.257 The changes proposed to the CRAare sweeping, and Congress is unlikely to adopt them without a seri-ous clash over the purposes and goals of the CRA, as well as anairing of the accusations that it was to blame for the crisis. Indeed,Rep. Jeb Hensarling has introduced competing legislation thatwould repeal the CRA entirely.258 While it is unlikely that CRA re-peal could get through Congress or past a presidential veto, someform of CRA reform is possible, and the following is a descriptionof the key elements of the CMRA.

The CMRA attempts to accomplish seven major changes to theCRA. First, it calls for the repeal of regulations enacted in the lastdecade that imposed a lighter CRA burden on mid-sized banks.259

Second, it would overhaul the ratings process by adding to therange of ratings that can be assigned to institutions covered by theCRA (adding grades of “low satisfactory” and “high satisfactory”),260

requiring the generation of a separate CRA grade for each financialinstitution’s assessment area,261 expanding the definition of CRAassessment area262 and requiring regulators to downgrade banksfound to have engaged in predatory lending and other unfair prac-

256. H.R. 1479, 111th Cong. (2009).257. The CMRA has the following “purposes”:

(1) To enhance the availability of financial services to citizens of all economiccircumstances and in all geographic areas.(2) To enhance the ability of financial institutions to meet the capital andcredit needs, and needs for other banking and financial services of all citizensand communities, including and especially minority and low- and moderate-income communities and populations.(3) To ensure that community reinvestment keeps pace with developments inthe financial industry and with the affiliation of banks, securities firms, andother financial service providers, as provided by the Gramm-Leach-Bliley Act.

Id. § 3.258. Fair Access to Credit and Job Creation Act of 2010, H.R. 5038, 111th

Cong. (2010).259. H.R. 1479 § 101.260. Id. § 103(a).261. Id.262. Id.



tices.263 Third, it would require any financial institution receiving afailing CRA grade (i.e., “Low Satisfactory,” “Needs to Improve,” or“Substantial Noncompliance”) in any assessment area to submit acorrective action plan to its regulator.264 Fourth, it would expandthe types of financial institutions covered by the CRA to includenon-depository mortgage lenders,265 insurance companies,266 se-curities companies267 and credit unions.268 It would also make CRAcoverage of affiliates of covered institutions mandatory.269 Fifth, itwould impose new reporting and disclosure requirements on cov-ered institutions.270 Sixth, it would make concern for communitiesof color an explicit purpose of the CRA, whereas now the CRA onlyaddresses bank services to “low- and moderate-income communi-ties” with no explicit mention of the race of those communities.271

Seventh, it would enhance the regulators’ ability to conduct publichearings on financial institution applications for which CRA reviewis appropriate.272

These changes are not only welcome, but are necessary if theCRA—perhaps the strongest federal legislation designed to lowerbarriers to credit for low- and moderate-income communities—is toserve its core purposes. Moreover, short of a progressive tax struc-ture and funding for public education, the CRA serves as one of thefew federal laws specifically designed to lower social distance, to theextent that such distance is created and strengthened by an en-trenched financial system that remains resistant to overcoming alegacy of racial discrimination. As discussed above, the CRA’s manyloopholes, and its anachronistic focus on narrowly drawn assess-

263. Id. § 104(a).264. Id. § 103(a).265. Id. § 108(a), (b)(3).266. Id. § 109(a).267. Id. § 107(a).268. Id. § 111.269. Id. § 102, 110.270. See, e.g., H.R. 1479 § 105 (expanding Equal Credit Opportunity Act to

include reporting requirements for small business lending); see also id. § 203 (re-quiring development of reporting methods for insurance companies).

271. Id. § 2(3).272. Id. § 303. More recently, a bill was introduced in the House of Repre-

sentatives, the American Community Investment Act of 2010, H.R. 6334, 111thCong. (2010), which attempts to accomplish many of the same goals of the CRMAin a more streamlined fashion. See Press Release, Rep. Gutierrez et al., Rep. Gutier-rez Initiates Effort to Modernize Community Reinvestment Act: In IntroducingAmerican Community Investment Reform Act of 2010 (Sept. 29, 2010), available athttp://www.gutierrez.house.gov/index.php?option=com_content&task=view&id=617&Itemid=55.



ment areas and depository institutions, meant that it was ill-suitedto prevent the rush of subprime lending in communities that theCRA was ostensibly designed to protect. In order to serve the CRA’spurposes, and make it relevant to banking in the twenty-first cen-tury, the changes proposed through the CMRA seem wise andnecessary.273

C. Social Capital, Social Distance, Regulatory Reform, andFinancial Crises

Financial institutions that did not engage in risky lending orenter the market in exotic derivatives during the buildup to thecrisis have weathered it much better than the large commercial andinvestment banks.274 Without a massive infusion of Troubled AssetRelief Program (TARP) funds, many more banks would have cer-tainly collapsed.275 The faceless, nameless, opaque transactions thatbrought down some of the most venerable financial institutionswere devoid of social capital—ties of trust and reciprocity that re-duce the risk of non-cooperative or predatory conduct.

At the same time, financial transactions infused with social cap-ital—the type of lending that occurred at community banks andother financial institutions that were “lower to the ground”—per-formed better than the innovators of high finance. One recentstudy of microlending revealed that increased contact between par-ticipants in meetings of borrowers decreased both social distanceand default rates by participants in the program.276 Is there a way to

273. For a further discussion of the CMRA and additional ways to strengthenthe CRA, see Raymond H. Brescia, A CRA for the 21st Century: Congress Considers theCommunity Reinvestment Modernization Act of 2009, 28 BANKING & FIN. SERVICES POL’YREP., Oct. 2009, at 1.

274. See Raymond H. Brescia, Trust in the Shadows: Law, Behavior, and FinancialRe-Regulation, 57 BUFF. L. REV. 1361, 1419–22 (2009) (and citations containedtherein).

275. See Donny Wise, Rapid Reaction via TARP Diverts Collapse at the Cost of Ac-countability, EXAMINER.COM (Apr. 11, 2010, 4:30 AM), http://www.examiner.com/consumer-and-banking-in-washington-dc/rapid-reaction-via-tarp-diverts-collapse-at-the-cost-of-accountability (“As the economic crisis spread rapidly in September2008, the government intervention in the financial system via TARP was a neces-sity, and the quick action saved the economic and societal collapse of the UnitedStates.”).

276. Benjamin Feigenberg et al., Building Social Capital through Microfinance3–4 (Nat’l Bureau of Econ. Research, Working Paper No. 16018, 2010), available athttp://www.nber.org/papers/w16018. Similarly, another study of microlendingfound that a high level of trust between borrower and lender improved repaymentrates. Asif Dowla, In Credit We Trust: Building Social Capital by Grameen Bank in Ban-gladesh, 35 J. SOCIO-ECON. 102, 108 (2006). A study of domestic credit unions



take such lessons to scale and capture the benefits of social capitalin financial transactions?

A grassroots movement is afoot that attempts to do just that.The “Move Your Money” campaign was hatched by Arianna Huf-fington and others in late 2009 as a way to bring community bank-ing values back to retail banking.277 This effort is designed toconvince retail banking consumers to utilize the banking services offinancial institutions with strong ties to local communities.278 Usinga risk assessment tool developed by Institutional Risk Analytics,279

the Move Your Money Campaign claims that over 2 million partici-pants, moving $5 billion in assets, have ended their relationshipwith their large banking institutions.280 Institutional and govern-mental investors have also adopted similar tactics. Municipalities,universities, unions, and public pension funds have either pledgedto invest and bank with community-based institutions or have at-tempted to exact compliance with demands for behavioral changesfrom the larger institutions, like improved performance in terms ofmodifying mortgages.281

found that longer-term credit union members had better repayment rates onmicro-loans than new members. See Marva Williams, Cooperative Credit: How Commu-nity Development Credit Unions are Meeting the Need for Affordable, Short-Term Credit,WOODSTOCK INST., 17 (May 2007), http://www.economicintegrity.org/pdf/cooperativecredit_may2007_williams-1.pdf.

277. Arianna Huffington & Rob Johnson, Move Your Money: A New Year’s Reso-lution, HUFFINGTON POST, Dec. 29, 2009, http://www.huffingtonpost.com/arianna-huffington/move-your-money-a-new-yea_b_406022.html. For a critique of theMove Your Money campaign, see Martha C. White, Does Boycotting Big Banks MakeSense? No. (Sorry, Arianna), SLATE: THE BIG MONEY (Jan. 4, 2010), available at http://www.thebigmoney.com/articles/hey-wait-minute/2010/01/04/does-boycotting-big-banks-make-sense?page=full.

278. Huffington & Johnson, supra note 277 (The movement advocates that“[i]t’s time for Americans to move their money out of these reckless behe-moths . . . . [B]ig banks are the core of the problem. We need to return to thestable, reliable, people-oriented approach of America’s community banks.”).

279. See Move Your Money, Special Report: Big Four Banks Deposits Change Survey,INSTITUTIONAL RISK ANALYTICS, http://us1.irabankratings.com/MoveYourMoney/IRADeposits_MYM_TBTF.asp (last visited Dec. 29, 2010).

280. Dennis Santiago, For Biggest Banks, Deposits Remain Sticky, HUFFINGTON

POST, May 10, 2010, http://www.huffingtonpost.com/dennis-santiago/for-biggest-banks-deposit_b_569655.html (dividing net deposit outflows for major banks byassumed average account value of $2,500).

281. See, e.g., Steven Greenhouse, New York Presses Banks on Foreclosures, N.Y.TIMES, July 13, 2010, at B3, available at http://www.nytimes.com/2010/07/14/business/14foreclose.html (detailing efforts of elected official and union leadersto pressure banks to improve loan modification efforts); Steve Flynn, A Proposal forNew Thinking on University Endowments and Community Investment, RESPONSIBLE EN-

DOWMENTS COALITION BLOG (July 20, 2010, 5:52 PM), http://www.endowment



Efforts to break up the large banks by putting asset caps onsuch banks—by, for example, pegging their size to no larger than apercentage of U.S. gross national product—failed during the crea-tion of financial reform legislation.282 Instead, a consumer move-ment—both individual and institutional—may stand a betterchance than regulation of re-infusing financial transactions with el-ements of social capital, by driving the reform of institutions, bothlarge and small, to take less risk, maintain better customer rela-tions, reinvest in local communities and meet local priorities. Suchefforts are well under way, yet it would be premature to attempt togauge their success in meeting such goals.

V.CONCLUSION

If we are to believe that a lack of trustworthiness and an excessof predatory conduct helped feed the subprime mortgage bonfire,it is essential to restore checks and balances to the financial systemthat would restrain such conduct and incentivize trustworthy behav-ior in mortgage lending and other financial practices. We also needto reduce social distance, both economic and racial. To do so wouldrequire both a greater enforcement of the laws on the books—thecreation of the CFPB and the DOJ’s recent announcement of thecreation of a new fair lending unit are also helpful—as well as astrengthening of laws like the Community Reinvestment Act by clos-ing loopholes that permitted predatory lenders to thrive.

We also have to recognize the role that law can play in foster-ing trustworthy conduct. Behavioral economists like Dan Ariely tellus that without rules, people cheat.283 Members of the law and eco-nomics school, like Richard Posner, tell us that the microeconomicincentives in place in the lead up to the financial crisis helped to

ethics.org/news-media/archives/305 (urging investing university endowmentswith community banks).

282. See Implications of the ‘Volcker Rules’ for Financial Stability: Hearings Before theS. Banking Comm., 111th Cong. 5 (2010) (testimony of Simon Johnson, Professor,MIT Sloan Sch. of Mgmt.), available at http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=98845464-f06e-4f20-b1bd-cbce9a87803c(opposing asset caps on banks pegged to GDP). The Brown-Kaufman amendmentwould have adopted such asset caps as part of Dodd-Frank, but the amendmentfailed. Tim Fernholz, On the Death of Brown-Kaufman, TAPPED: THE GROUP BLOG OF

THE AM. PROSPECT (May 7, 2010, 4:16 PM), http://www.prospect.org/csnc/blogs/tapped_archive?base_name=on_the_death_of_brownkaufman&month=05&year=2010.

283. See DAN ARIELY, PREDICTABLY IRRATIONAL: THE HIDDEN FORCES THAT

SHAPE OUR DECISIONS 213 (revised ed. 2009).



encourage risky behavior and brought about the crisis.284 The anal-ysis presented in this Article suggests that an exploration of the rolethat greater social distance plays in decreasing trust and increasingpredatory conduct deserves its place at the table in conversationsabout how to reform mortgage markets, and markets in general.

284. See POSNER, supra note 75, at 75–112.



APPENDIX AData Set 1:

MEDIANHOUSEHOLD

INCOME MEDIAN HOUSEHOLD INCOME BY RACE

MHI by State White Black LatinoSTATE (Thousands) White Rank Black Rank Latino Rank

Alabama 38,783 71,195 2 51,726 1 58,093 1

Alaska 59,393 61,616 7 49,486 2 55,909 2

Arizona 47,265 65,641 5 40,499 13 55,322 3

Arkansas 36,599 59,560 10 43,993 5 55,048 4

California 56,645 61,067 8 40,267 14 54,087 5

Colorado 52,015 47,970 28 0 51 45,899 6

Connecticut 63,422 55,225 15 43,027 6 45,392 7

Delaware 52,833 69,836 3 44,866 4 45,049 8

District of Columbia 51,847 56,379 12 33,151 24 43,877 9

Florida 45,495 60,415 9 40,709 11 43,805 10

Georgia 46,832 48,528 26 41,170 10 43,660 11

Hawaii 61,160 88,969 1 34,484 22 43,547 12

Idaho 42,865 47,749 30 32,554 25 40,510 13

Illinois 52,006 55,907 13 41,640 8 39,199 14

Indiana 45,394 46,691 35 23,986 46 38,776 15

Iowa 44,491 44,494 40 48,623 3 37,786 16

Kansas 45,478 53,936 19 33,563 23 37,692 17

Kentucky 39,372 35,454 51 21,554 50 37,631 18

Louisiana 39,337 47,412 31 27,140 38 37,439 19

Maine 43,439 49,566 23 41,198 9 37,288 20

Maryland 65,144 52,179 20 39,744 15 37,157 21

Massachusetts 59,963 55,724 14 30,120 29 36,850 22

Michigan 47,182 45,331 37 27,808 37 36,738 23

Minnesota 54,023 50,309 22 31,276 28 36,372 24

Mississippi 34,473 54,118 18 40,659 12 36,222 25

Missouri 42,841 67,852 4 41,648 7 36,217 26

Montana 40,627 57,021 11 37,107 18 36,147 27

Nebraska 45,474 40,521 49 26,595 40 36,098 28

Nevada 52,998 54,690 17 34,563 21 35,941 29

New Hampshire 59,683 45,222 38 27,017 39 35,789 30

New Jersey 64,470 47,036 33 29,293 31 35,744 31

New Mexico 40,629 46,525 36 28,423 35 35,639 32

New York 51,384 47,291 32 29,309 30 35,484 33

North Carolina 42,625 43,139 45 21,969 49 35,378 34

North Dakota 41,919 47,902 29 26,473 41 35,313 35

Ohio 44,532 50,794 21 26,161 42 34,332 36



Oklahoma 38,770 46,946 34 29,076 34 34,220 37

Oregon 46,230 43,731 42 38,006 17 33,789 38

Pennsylvania 46,259 49,207 24 32,159 26 33,354 39

Rhode Island 51,814 48,179 27 29,243 32 33,187 40

South Carolina 41,100 48,768 25 29,111 33 32,454 41

South Dakota 42,791 43,347 43 32,074 27 32,085 42

Tennessee 40,315 42,919 46 28,067 36 32,049 43

Texas 44,922 44,788 39 25,203 43 31,930 44

Utah 51,309 43,317 44 22,931 48 31,516 45

Vermont 47,665 43,915 41 35,941 19 31,343 46

Virginia 56,277 40,009 50 23,265 47 30,704 47

Washington 52,583 55,133 16 35,183 20 30,499 48

West Virginia 35,059 62,443 6 38,496 16 30,140 49

Wisconsin 48,772 41,741 47 24,119 45 29,838 50

Wyoming 47,423 41,604 48 24,365 44 27,165 51



Data Set 2:

PERCENT OFSTATE

INCOME POPULATION:INEQUALITY BLACK TRUST POVERTY

% Black GSS: “Most PercentageInequality Inequality % Black Pop. people can of people

STATE Rate Rank Pop. Rank be trusted” in poverty

Alabama 0.475 46 7.2 24 23% 16.6

Alaska 0.402 3 . . . 10.9

Arizona 0.45 29 37.3 48 47% 14.2

Arkansas 0.458 35 29.6 46 29% 17.3

California 0.475 42 26.2 43 43% 13.1

Colorado 0.438 28 31.5 47 46% 12

Connecticut 0.477 49 16.7 39 49% 8.3

Delaware 0.429 15 28.6 44 . 11.1

District of Columbia 0.549 51 . . . 19.6

Florida 0.47 43 3.2 13 37% 12.6

Georgia 0.461 38 21.2 42 38% 14.7

Hawaii 0.434 18 . . . 9.3

Idaho 0.427 6 7.3 25 . 12.6

Illinois 0.456 40 11.4 31 44% 12.3

Indiana 0.424 13 15.5 38 43% 12.7

Iowa 0.418 7 14.9 37 56% 11

Kansas 0.435 20 13.2 33 55% 12.4

Kentucky 0.468 35 14.8 36 32% 17

Louisiana 0.483 48 1.8 11 33% 19

Maine 0.434 10 19.4 40 . 12.9

Maryland 0.434 14 28.7 45 42% 7.8

Massachussetts 0.463 38 14.6 35 46% 9.9

Michigan 0.44 23 10.2 29 51% 13.5

Minnesota 0.426 11 6.0 23 63% 9.8

Mississippi 0.478 45 11.8 32 17% 21.1

Missouri 0.449 26 7.3 25 44% 13.6

Montana 0.436 9 8.7 27 64% 13.6

Nebraska 0.424 11 4.6 19 . 11.5

Nevada 0.436 15 20.4 41 . 10.3

New Hampshire 0.414 3 14.0 34 62% 8

New Jersey 0.46 33 3.2 13 41% 8.7

New Mexico 0.46 32 0.4 1 . 18.5

New York 0.499 50 11.3 30 40% 14.2

North Carolina 0.452 33 5.7 21 27% 14.7



North Dakota 0.429 15 9.2 28 67% 11.4

Ohio 0.441 26 5.5 20 41% 13.3

Oklahoma 0.455 35 3.6 16 39% 17

Oregon 0.438 23 0.8 5 55% 13.3

Pennsylvania 0.452 30 1.0 8 44% 12.1

Rhode Island 0.457 21 1.6 10 52% 11.1

South Carolina 0.454 40 5.8 22 34% 15.7

South Dakota 0.434 19 3.3 15 . 13.6

Tennessee 0.465 44 0.6 3 36% 16.2

Texas 0.47 47 1.0 8 33% 16.9

Utah 0.41 1 2.2 12 54% 10.6

Vermont 0.423 5 4.0 17 59% 10.3

Virginia 0.449 31 0.5 2 38% 9.6

Washington 0.436 22 4.4 18 46% 11.8

West Virginia 0.468 25 0.8 5 30% 17.3

Wisconsin 0.413 7 0.7 4 52% 11

Wyoming 0.428 2 0.9 7 60% 9.4

Data Set 3:

TABLE P-Value

Table 6: Income Inequality and Delinquency Rates by State 0.011224

Table 7: Poverty Rate 0.800896

Table 8: Median Income by State 0.056502

Table 9: Median Income by Race White: 0.061754

Black: 0.048303

Latino: 0.501179

Table 10: Trust and Delinquencies 0.070695

Table 11: Trust and Crime Rate Rank 0.000678

Table 12: Delinquency Rate Rank and Crime Rate Rank 0.097418

Table 13: Social Capital and Unemployment Data <8 Unemployment Rate: 0.017062

8-10 Unemployment Rate:0.047184

>10 Unemployment Rate:0.752530

Table 15: Targeting the Black Middle Class Overall: 0.0000583 or 5.83x10-5

State Level Inequality andDelinquencies: 0.011224Percentage African AmericanPopulation and Delinquencies:0.039541African American Median Incomeand Delinquencies: 0.048303